Which is Worse, Fear or Greed?
When comparing our reflex for greed versus fear, we can see greed tends to be driven by something elusive: we want, we get, we no longer want that, but something else. Fear is more direct, less sneaky in its aims, and more forceful in moving us to act.
Central banks like the Federal Reserve have been willing to go to extraordinary lengths to stem fear in financial markets. Congress passed the largest spending bill in US history in 2020 after fear stoked during the Covid lockdowns sent the economy into a spiral. Both the Fed and Congress acted quickly and carelessly, opening up what proved to be the biggest opportunities for fraud and graft in the past 100 years. Their concern was greater that fear would take hold than the inevitable greed they would unleash.
Considering the Velocities
When greed is the contagion, its velocity is uneven, spreading in fits and starts. For greed to spread it requires the breaking down of investor ethics and moral fortitudes. It requires the abandonment of sound investing practices and wisdom. The spread of greed is a process that doesn’t take place overnight. It can take many months or years to pull enough investors into the mindset where greed overwhelms their sense of reason.
When fear is the contagion, its velocity has the potential to go supersonic. It can spread like a wildfire consuming entire corporations, banks, and even nation-states in short order. Fear can derail an economy in a matter of weeks and lay waste to investors' fortunes in a matter of hours. Unlike greed, there are fewer societal obstacles to fear. Greed is frowned upon, but fear is rarely treated with such disdain. Fear is often embraced as sensible and even as a sign of wisdom, and the fact is, sometimes it is indeed wise to be fearful. But it only takes the loss of wisdom with respect to that fear to turn fear into the most destructive force found in human nature.
Fear, historically speaking, is the more destructive force, and therefore, where investing is concerned (so not spiritually speaking) fear is worse than greed. For this reason, it is incumbent on investors to safeguard themselves from acting out of fear. Greed requires moderation, but fear must be very carefully managed.
Overcoming The Enemy
With a clear understanding of the ways fear and greed can lead investors into losses or limit them to meager profits, there are a series of tools an investor can adopt to help shield themselves from the effects of these reflexes:
(1) Measure the value of an asset by traditionally objective measures. In real estate if an asset provides a positive income after your costs associated with financing, maintenance, management, margins of safety, and other associated fees are accounted for, it is objectively a good investment. For stocks, there are a set of metrics you can use to assess the company from a value-investing standpoint. Warren Buffett has famously used this method with great success. I’ll devote a future post to this valuation process. In short, do not ignore the fundamentals. Yes, this will mean missing out on stocks like Amazon, Tesla, and Google and investments like Bitcoin, but only as a significant investment. An effective contrarian investor allocates a small percentage of their investment funds to speculative “moonshot” opportunities, which can grow into meaningful amounts in the long run.
(2) Don’t chase a winning investment and always have an exit plan. One way to avoid getting caught up in a stock frenzy is to exercise discipline in your method of investing. Where you see a momentum play and in your analysis of the investment you think it is fairly valued, make the investment, but then stick to a pre-determined exit plan for your investment. Sir Isaac Newton famously chased his successful South Sea Company stock investment by increasing his stake after selling his first investment in the company at a considerable profit. In the end, he likely lost three times more than he made from the original investment. When a stock rises by a meaningful amount, take some off the table. If it rises again, take some off the table again. Once you’ve recouped your original investment plus a decent profit (I consider 20% to be decent), if the stock appears to still have legs, for what remains you can “let it ride”, but even then have in mind the point at which you want to exit the investment.
(3) Dollar Cost Averaging. This is a very pragmatic and effective means of beating back the reflexes of greed and fear. The method is deceptively simple: be a buyer regardless of what the market is doing. This is an especially effective tool when buying index funds, but can also guard against big losses in quality individual stocks during times of mass market unrest. It will truncate the size of your profit potential (limiting greed) but also scales back losses as you keep buying (limiting the effects of fear) when a stock is down, allowing you to acquire cheaper shares in the process. Key to the effectiveness of this method is discipline. Be a buyer in all seasons until the time you decide to exit the investment altogether based on a pre-determined date (tied to retirement plans) or for a pre-determined purpose (acquisition of a productive asset).
(4) Spread of Risk. It’s in line with the old saying “don’t put all your eggs in one basket.” Where investing is concerned, many of us are content to go with a financial planner’s advice and invest almost exclusively in the financial markets (stocks, bonds, mutual funds, ETFs, commodity funds, Real Estate Investment Trust (REIT) funds, etc. They typically only deviate from this narrow field of investing advice - presented as providing a good spread of risk to the unschooled investor - by suggesting annuities and insurance products (life and long-term care) and an emergency fund in a bank savings or money market account. They are generally compensated for putting your money in these investments (Fiduciary CFPs being an exception), so of course, they will steer you to such solutions.
Don’t get me wrong, these are good ideas as a solid part of your financial planning (and I’ll dedicate a post to insurance down the road), but I am inclined to disagree if they say to me “You’ll have a good spread of risk” when invested entirely in financial markets, banking, and insurance. Why? Because these entities are all so closely tied together that when one begins to unravel, we see the entire system in danger of unraveling. In 2008, the financial crisis started with Lehman Brothers (a brokerage and investment bank) but then quickly spread to other brokers, banks, and insurance companies.
True spread of risk includes a spread of the sources of income that fill the bucket you need to live off of. So, having owned productive real estate can be a tried and true major alternative source of income. Even then, as you expand your real estate portfolio work to own real estate in more than one city or even state. It has also never been easier as an individual to earn money from your creative talents like writing, coding, illustrating, music, voice work, a knack for fashion - personal shopping, etc. If you have a particular talent, research on the Internet how you can monetize it online to create an additional income stream. Yes, this can become just another job on top of the one you already have so the best opportunities will be those where you create something once and then collect royalties or use fees going forward. In terms of non-productive assets, things not directly subject to financial markets and will exist on their own apart from those markets, can help you weather a fear storm when it strikes. For example, ownership of physical precious metals, crypto (yes, crypto), and collectibles (your mix driven by your particular competencies).
(5) Eliminating Leverage. Put this idea in the Dave Ramsey category. I am a fan of Mr. Ramsey’s approach to getting out of debt. It is designed to be followed by just about anyone to achieve that particular goal: becoming debt free. Given my goal for you to be financially independent, he and I share a similar interest. I agree your best starting point is to become debt free, but we deviate from that point in that I am okay with the idea of taking on debt going forward so long as it is attached to a productive asset (so the asset covers any debt service costs and then some). But, when it comes to making a plan to keep fear at bay, owning your productive assets outright (no debt) is the best way to keep you resting easy in a fear-storm. It can take a bit more time and you can use proceeds (like I’ve done) from successful moonshot speculative investments to get there faster, but the elimination of leverage should be a part of your long-term financial plan if you want to be truly hardened against economic calamity.
There are other techniques to combat fear and greed but to summarize the above solutions, each of them requires advance planning, intentional investing based on the plan, and then disciplined decision-making to execute according to the plan. If the plan is a poor one, the outcomes will not be good regardless of the planning, so in developing your plan look at each of the five tools above to see if at least two or more of these have been included in your plan to fight off the beasties of fear and greed.
Until next time, may peace and prosperity be with you.
The Natural Economist
Next up: Is Financial Independence About What You Make? Yes and No.