We have already demonstrated that investors are susceptible to various biases—namely, overconfidence bias, herd mentality, and FOMO. At the root of these biases are human emotions,which often lead to irrational investment decisions. In Part 3, we will focus on the emotions of fear and greed, which are even more fundamental than the aforementioned biases with respect to making basic investment decisions. According to Kirk Chisholm of Innovative Advisory Group, the stock and bond markets are primarily driven by fear and greed, which are strong primal emotions, not something we can overcome easily.
Legendary investor Warren Buffett’s statement about fear and greed crystallizes the dynamic that permeates every aspect of investing: “Be fearful when others are greedy and greedy when others are fearful.” Buffet’s extraordinary success as an investor is tied to his ability to separate his emotions from any prevailing market condition. In fact, he’s used herd mentality to his advantage.
This is in contrast to the typical retail investor who is victimized by their own emotions, doing the exact opposite of what Buffet preaches: selling low and buying high, or buying and selling into extreme greed and fear cycles, respectively.
Looking back on the 2008-2009 market meltdown, the Dow Jones Index lost half its value in less than a year, and millions of investors saw billions of dollars in assets disappear. Many investors pulled money out at or near the bottom. Five years from that 2009 market bottom, the Dow was up roughly 10,000 points to a record 16,000. Patient investors were the winners. James Glassman of Kiplinger once said that “making money in the stock market is hard not because finding great companies is difficult but because the best and easiest-to-understand strategy for winning is so difficult to adhere to. That strategy can be described in three words: buy and hold.”
Greed is probably an easier emotion to understand—we have all experienced it. Certainly, it can drive us to achieve great things by wanting more for ourselves and our family, but the flip-side of this emotion can lead to devastating outcomes. The history books run rampant with stories of well-intentioned people succumbing to the seductive powers of greed, losing sight of right and wrong over time. When an investor falls into the trap of greed, decision making becomes impaired, and they become highly vulnerable to taking on more risk than is suitable.
The past few years have provided strong market returns, annualizing at about 26%. This far exceeds the long-term historical average, which is about 9%. Typically, we see massive inflows into stocks not prior to a three-year period of strong returns, but afterward. Think of it as driving your car while looking into your rear-view mirror—not the best way to navigate what’s to come. Leading with greed will manifest a fixation on missed opportunities and an overconfidence in past results—both of which are detrimental to an investor’s forward-looking strategy.
The prevalence of fear and greed are always in play, but when investors succumb to their emotions and let their ability to rationally assess risk and opportunity fall to the wayside, these exact emotions are often what motivates them to act at precisely the wrong time. Fortunately, professional financial advisors can be the voice of reason and help retail investors avoid these pitfalls.
What Professional Advisors Bring to the Table
The key to combating behavioral drivers such as fear and greed is having a premeditated, all-encompassing, long-term plan in place to act as a guide during times of distress. To help investors manage their emotions and guide them through high-stress environments where their emotions are running rampant, battle-tested and experienced wealth management professionals set up long-term financial plans with corresponding goals and objectives based on a client’s lifestyle and retirement needs. This planning-based approach, rooted in reality, discipline, and facts, allows the advisor/client partnership to navigate life and the accompanying investment plan unemotionally and with a keen sense of what needs to happen in order to be successful.
With more than 25 years of investment experience on average and with partner tenure that exceeds 30 years, the Summa Group has been through many market ups and downs and has successfully helped clients navigate through different types of investment environments. We attribute much of our success to our unemotional, systematic, and disciplined investment approach and our “win by not losing” philosophy. The Summa Group’s proprietary research and due-diligence process are foundational contributors to our success and leverage the team’s financial planning capability.
Portfolio Management and Manager Research
Successful investors come in many forms, but because we tend to advise families who have already built a strong balance sheet of liquid and illiquid assets, we believe the consistent application of our process every day leads to more predictive and consistent outcomes for our clients. We intentionally live in a more narrow range of possibilities and, consequentially, are willing to accept less of the upside in exchange for less of the downside. Our research and due-diligence efforts result in client allocations that are dynamic, flexible, and fluid as we attempt to build a safety net for each of our clients. This approach is far different from one that attempts to generate outsized gains without regard for risk and the possibility of permanent loss.
Macro Research and Analysis
Our relationships across Wall Street provide our team with access to high-quality research on all aspects of the global capital markets, economy, trends, themes, and other factors that need to be considered as we build a client’s asset allocation. We tend to be strategic in how we allocate capital, but there is a tactical element to what we do, driven by our collective macro view. Removing the behavioral and psychological aspects of investment allows us to focus on what we can control, which is our process.
Our team gathers various research and insights from economists and thought leaders in the industry on a weekly basis to form our own balanced perspective. We believe it is important to consider all major views and data points before making any investment decisions. No matter how convinced we may be about a specific opportunity, we will not execute in a way that puts our client in harm’s way. Over the years, we have made many marginal moves that have been complementary of our near-term thesis and beneficial to our long-term strategy. Our consensus view, driven by our access to high-quality information from many sources, eliminates the dangerous dynamic of “group-think.” There must always be a platform to express opposing views no matter how unpopular.
The chart below shows that, historically, the market drawdown for a given year is 14% on average, but still finishes the year positive most of the time. Having this knowledge helps us understand why market corrections are a necessary and welcome ingredient to long-term investment success. More importantly, this historical perspective helps novice and unsophisticated investors avoid the emotional pull of fear and greed.
Learning From History With Eyes on the Future
Lessons from the past can be used to make educated and unemotional decisions in the future. The challenge in all of this is driven by the common belief that “it’s going to be different this time.” We have conversations with people all of the time who are highly intelligent, believe what they believe,and are usually going to make a move regardless of what a more reasonable and unemotional person might recommend. As financial bubbles grow in size and breadth, the general population slowly becomes seduced by the idea of outsized wealth creation.
FOMO plays a huge role in all of this. Even the most level-headed investors can be sucked into the powerful vacuum of greed and will abandon disciplines that have been in place for years. The list of people who have lost everything as a result of this dynamic is long and rife with stories that seem hard to believe.
We refrain from making predictions about the future. Through a strict adherence to a battle-tested investment discipline and process, we can objectively make decisions on behalf of our clients that put them in the best possible situation to have successful outcomes. Bubbles will always be part of the investment landscape, so it’s important to be able to recognize the behavioral patterns and quantitative factors behind them.
Clearly, the mass proliferation of social media around the world, with little in the way of checks and balances to decipher legitimacy from illegitimacy, has only added to the “bubble” dynamic. The perfect storm has little to do with whether something is real or justified and more to do with how quickly information travels and how difficult it is to quantify its legitimacy.
This series of articles attempted to bring a historical context to the inevitable formation of bubbles and how we as investors and advisors can navigate the challenges that market euphoria presents. Awareness of the fear and greed cycle that is so prevalent among generations of investors can go a long way toward staying out of harm’s way. Of course, FOMO and the idea that it’s going to be different this time add to the temptation of doing the wrong thing at the wrong time.
Elite investment advisor teams are tasked with providing their clients with advice, capabilities, investments, planning, guidance, and many other services that are likely to protect clients from the unexpected. One of our most important roles has nothing to do with what our firms can provide—and everything to do with keeping our clients on plan while avoiding the big mistakes.
Brian Werdesheim is Managing Director of Investments with The Summa Group of Oppenheimer & Co. Inc., a wealth management company ranked as one of the top financial advisors in the United States.