Having someone who is paying attention to your investment day-by-day can help stave off the emotions that can negatively impact your investment.

In looking at recent news in the investment world, it seems like an amazing time to hop into the stock market. With it reaching record highs, who wouldn’t want to hop into the market right now? And given the fact that many people spent the last ten years in fear of what might happen to their investment, the recent climate probably feels like a breath of fresh air.

But consider the following.

What is the Cycle of Fear and Greed?

The cycle of fear and greed occurs when the market shifts dramatically positively or negatively, and investor behavior follows–or matches the shift in an effort to take advantage of the change–but in a way that accomplishes the exact opposite of the investor’s intent.

What do I mean?

In short, when the market is doing well, individual investors tend to buy. When the market is doing poorly, investors tend to sell. You probably think that’s logical, right? Not exactly.

Let’s take a look at the tech bubble at the beginning of the millennium as well as the most recent real estate catastrophe. The most money went into the market right before the tech bubble–and the market dropped. Then–investors took the most out right before it went back up. Individual investors invested when the market was at its top–they were greedy, yet sold at the bottom when the fear got too much.

What does the historical data tell us? (First, the numbers and data from Morning Star show that in 2000 $121 B went into the stock market, flowing into stock mutual funds, while in 2001 the stock market was down 11.8%. A tremendous amount of money went in right before the market plummeted.

  1. Next, in 2002, $27 B came out of the stock market. Yet in 2003, the market was up 28.68%. Around 10% of the investment was made when the market was low.
  2. Then, in 2008, $151 B came out of stock mutual funds. Then in 2009 the market was up 26.47%.

Again, I’ll repeat myself, most individual investors get stuck in the cycle of fear and greed. They fear when the market is down–and sell, then they get greedy when the market is up–and they buy. The purchasing statics above underscore that behavior.

Consider the following:

Between the years 1991 and 2010, the stock market drove a 9.1% return. If you were an individual investor and missed the 30 best investing days over that 19 year period, your return was only .9% annually, missing nearly 10% of the market return.

Then if you missed the 40 best investing days, you were actually DOWN 1% annually. If you missed the 50 best days, you were down 2.7%.

Basically, if you went it alone and tried to time–and missed–the best days, you gave up all of the return.

A Hidden Threat

You might ask yourself, “if I understand the cycle of fear and greed, can’t I just predict the next financial crisis?”

Not necessarily.

Often, investors tend to look at last crisis to learn about next one. But when you look at how things actually happen, a financial crisis doesn’t immediately repeat itself. The tech crisis of 2001 wasn’t followed by another tech crisis in 2008. It was followed by a crisis in real estate. And there’s a decent chance that the next financial crisis won’t be in real estate.

So, How Do You Avoid the Cycle of Fear and Greed?

The answer might seem counter intuitive. Basically, you need to be able to avoid all of the emotions attached to market activity. When investors see the market rise, they want to buy–or suffer feeling like they’re missing out. When investors see the market fall, they tend to sell and deal with the agony of loss.

I’ll admit–when your watching the markets rise–and you’re not jumping on the same ship as everyone else–it can feel like you’re missing out. But by having someone who is paying attention to the market day-by-day or hour-by-hour, you don’t have to pay attention when fear or greed is at its peak.

Ideally, an investment advisor will help you design a transparent investment portfolio that meets your needs and is managed with an objective long-term view. When we as investment advisors see that markets are cheap, and a stock aligns with your investment strategy, we will work to get you in–which is the exact opposite to what an individual investor would do. In a nutshell, we help you smooth out volatility in the stock market, insulating you from the cycle of fear and greed.

Have you gotten caught up in the cycle of fear and greed? If so, how’d you get out? Or… are you still in it and looking for a way out?