How greed and fear can really kill returns.
The famous investment philosophy: buy fear, sell greed – promotes the idea that we should be buying stocks when everyone else is fearful of the market (buying at a low price) and selling stocks when everyone is excited about the market and expects it to keep going up! The theory makes logical sense and, historically speaking, would have been a good way to invest over the years. Unfortunately, instead of looking at investing logically, many investors make decisions emotionally.
The chart below shows the stock market growth as represented by the S&P 500 over the last 20 years, along with inflows and outflows to bond and stock mutual funds. As you can see, investors do not buy fear and sell greed. Instead, they sell fear and buy greed, despite knowing on an intellectual level that it is a very bad idea. At the top of the market, investors can’t seem to buy enough stocks, and at the bottom they can’t sell enough. Mistakes like this can ruin your retirement plan. The chart illustrates just how much emotion is tied to investment decisions. If you sold at or near the bottom in 2008, you will probably never be able to make that money back again. Even worse, many of the same investors will only start putting their money back into the stock market when it is near another all-time high; habitually making the same mistake over and over again.
Want to make better investment decisions? Remember that when you are nervous about the market and all your friends are selling out and buying bonds, stay the course. Do not let emotion drive your investment decisions. Do not sell. Weather the storm. If you do so, odds are you will likely be far better off than anyone who sold on fear.
2012 Morningstar; Equity and Bond Fund Flows