Fear and Greed

What are you afraid of?

Are you afraid of losing money?

Are you afraid of not having enough?

Are you afraid to look at your bank account?

Of all the emotions you feel with investing, fear is the one that most controls you.

Fear is sometimes even an emotional driver for greed.

Fear leads to destructive behavior and desperation.

Fear sucks.

The opposite of financial fear is peace.

However, in financial markets the spectrum swings from fear to greed. In fact, there’s a metric used to track investor sentiment within the financial markets. Unoriginally called the Fear and Greed Index.

The Fear and Greed Index is an interesting stat to track, as markets don’t exist in a vacuum and are influenced by the emotions of all market participants (except the trading bots! maybe.) Two of the most common emotions investors experience which can influence markets are fear and greed.

Warren Buffett famously said to “be fearful when others are greedy, and greedy when others are fearful.” When people experience fear when investing, they tend to sell riskier assets in lieu of safer assets.

That is oftentimes a bad move, as people panic sell as prices fall and then are too afraid to buy back in. For most people, buying assets with a long term timeframe and holding on through the rollercoaster produces better results.

Here are a few reasons why people experience fear in markets. We’ll also cover ways you can reduce fear and anxiety to help you make better investment decisions.

1) Time horizon (high time preference)

If someone is buying a stock or cryptocurrency with the intention of making a quick gain, they have a high time preference. This means the person prioritizes immediate gratification (returns) and a shorter duration.

The higher your time preference, the more susceptible you will be to fear and anxiety. If a stock drops 10% in a day and you need the money tomorrow, then you will feel high anxiety about the market fluctuation.

If the same stock drops 10% in a day but you plan to hold it for 10 years, you may not even notice!

2) Misunderstanding the fundamentals

Without conviction or deep understanding for why you chose a certain investment, it’s easy to see the numbers go down and panic. This is why investing in businesses you understand and have studied reduce anxiety during short term volatility.

Legendary investor Peter Lynch once said, “Know what you own.” This is one of my all-time favorite investing quotes, and it guides many of my personal investing decisions today.

The investments I’ve made into companies or projects I don’t fully understand are the ones in which I get rekt. Even if the company may be great, if I don’t understand it, I won’t touch it.

Diversifying is another way to avoid this pitfall. If you’re unwilling to do the work to fully understand what you’re buying, it might be better to choose a diversified index.

3) Investing more than you should.

If you’re feeling stressed about volatility, it could be a sign that you have too much money invested. When we invest more than we should, we feel the need to constantly watch the investment so we don’t “lose” the money.

I see this a lot within crypto markets — people invest their life savings into an extremely risky asset — and then feel immense regret if it rapidly declines in value.

If an investment is keeping you up at night, you may be over allocated. A way I like to think about allocations is to not hold any single position that, should it go to zero, my entire portfolio would be gone.

I’ve had to start over before. I do not want to do it again. Therefore I won’t allocate so heavily into any single asset that it risks my entire portfolio or long term plan.

4) Fear of Loss (Loss Aversion)

Loss aversion is a cognitive bias where people dislike losing money more than they like gaining money. This phenomenon was uncovered by Kahneman and Tversky in their research on prospect theory.

To illustrate, let’s say you found $100 on the street. You’d be pretty happy with that! However, if you lost a $100 bill that you had in your wallet, you would be more upset about the loss than you would be happy about finding $100. Even though the dollar amount is the same, we experience more pain due to losing money than we do gaining money.

This bias presents itself when investing as well. A 10% drop in our portfolio balance feels worse compared to the pleasure of a 10% gain in the portfolio.

What to do?

What do you do if you’re feeling stress about your investments?

• Be aware of your emotions when investing. Understanding Loss Aversion, Fear and Greed, FOMO, and other emotions can help you make better decisions when investment anxiety creeps in.

• Know what you own. By deeply understanding the investments you own, it will be easier to weather the storms in the market. This also goes back to time preference.

• Lengthen your time horizon. The further into the future you’re willing to hold, the less that day-to-day volatility matters. Historically, time in the market has often outperformed attempts to time market peaks and troughs.

• Be conscious of allocations. If you hold too much or too little of an asset, it can lead to anxiety. If you’re constantly worried about portfolio fluctuations, it could be a sign that you either

  • a) Don’t have high conviction in the asset and should do additional research to determine whether you want to continue owning the asset

    or

  • b) Too much of your portfolio is in concentrated in the asset

What other fears do we face as investors? And what practical ways do you regulate these emotions?