Are fear and greed harming your investments?

December 19, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Fear and greed are said to be the two most powerful motivations for investors. Unfortunately, investors tend to alternate between these potentially destructive emotions.

Collectively, investor greed and fear helps accentuate the up and down cycles of markets, and individually, otherwise sensible people can make irrational decisions based on these emotions. But if you can recognize some of the ways people tend to fall victim to fear or greed, it can help you avoid being influenced by these emotions.

Here are three common symptoms of greed and three common symptoms of fear. If you experience these symptoms in the course of your investing, it may be time to re-examine your motives.

Symptoms of greed

  1. Holding onto gains for too long. Investors tend to look at hot-performing stocks like superstar athletes: They expect them to continue to repeat their excellent performance over and over. The problem is, once the market recognizes an outstanding company, the upside becomes more limited and the risk increases. Don't be too reluctant to sell your winners and move on to the next opportunity.
  2. Chasing a rising market. In the 17th century, a mania for investing in tulip bulbs reached the point where a single bulb could cost an entire year's salary. Just within the past fifteen years, there have been bubbles in Internet stocks, real estate, oil and gold. For some reason, investments seem different than most other things people buy -- people are more attracted to them the higher their prices get. Greed is the culprit here. When a market seems to be providing easy money, everybody wants to pile on the bandwagon. That's why so many people tend to be in a market when it finally collapses.
  3. Falling for scams. With the stock market unreliable and savings account interest rates near zero, it's natural to look for alternatives. However, it's greed that gets people to put their trust in something they should know is too good to be true. These scams are surprisingly common. For every high-profile perpetrator like Bernie Madoff, there are perhaps hundreds of small-time scams offering impossibly high returns that the perpetrators claim are guaranteed. Don't believe them.

Symptoms of fear

  1. Panic selling. When you buy a stock, you need to have conviction in what you are buying, and why. Understand that the price will fluctuate up and down. As long as the fundamentals of the underlying company haven't changed, don't let a change in market price alter your perception of that company's potential value.
  2. Pulling out of a down market. Just as greed leads people to jump on a bandwagon when prices are high, fear pushes them off it when prices fall. Buy low and sell high seem like incredibly simple principles, but it is amazing how emotions like fear and greed can interfere with them.
  3. Not getting started. Sitting on the sidelines and putting off even beginning a retirement savings program is an unfortunate response to the oft-confusing stock market. But it may account for why personal savings rates have drifted lower as the market has become more turbulent. Remember though, low returns are actually a reason you need to save more, not less.

Investors constantly clamor for that extra piece of information that will give them an edge over the market. But the truth is that it is often more discipline -- not more information -- that will help them succeed.

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