Investing Behavior: Avoiding Fear and Greed In Your Financial Planning

I’ve had my fair share of interesting phone calls over the course of my more than 20-year career as a financial advisor. And two calls in particular stand out more than any other. Both came back in the dot-com bubble and bust of the early 2000s. If you don’t recall, it was an era marked by a thrilling market upturn–quickly followed by a disastrous downturn that wiped out many would-be tech millionaires.

I distinctly remember receiving a call from a client who, right at the peak of the market, told me: “I need more NASDAQ.” She saw her friends making money on tech stocks, and she didn’t want to miss out no matter how overheated the market seemed at the time.

Within days of the market bottom a couple years later, I received another call, this time from a client who was grieving over the fact that the NASDAQ had dropped some 60% and wanted to cash out. “I don’t see anything that will bring the stock market back in my lifetime,” he told me, while also wishing he had sold everything he had at the peak of the market.

Despite this client’s dire prediction, the market has clearly roared back with a vengeance in the years since. If you hung in for the duration, you would have done well for yourself–but it would have been a bumpy ride.

I share these stories as a way to illustrate the role that emotion and psychology play in our investing behavior. When times are good, we tend to make bigger and bolder bets–which exposes us to more risk. Then, when times are tough, we get scared and cautious–and then miss out on great buying opportunities.

I call this phenomenon of investing behavior “financial schizophrenia.” It was actually my dad who taught me how this worked, since he had a knack for selling low and buying high–which is exactly the opposite of what you want to do.

There’s a great quote from Sir John Templeton, which he says: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”  In other words, when it comes to investing, it can often pay to know which way the herd is heading.

One of the tools I have begun to rely on to explain this dynamic with my clients is called the CNN Fear & Greed Index.

When you go to the site, you’ll find what looks like a speedometer, which is a measurement of how investors are treating the market. Seven different indicators are used to come up with that calculation, which paints a picture of how greedy or fearful investors might be at any given time.

I find this information enormously useful because it’s an objective way to talk to my clients about what’s happening in the market and provide context for their own financial decisions.

For example, I have witnessed the market sustain gut-punches over the years–from the scares over SARS and bird flu to Brexit and Greece. But, when the market is full of fear, it might be time to actually think about doing some bargain hunting.

On the flip side, when the Fear & Greed Index has swung all the way over to the right–when people are full of greed–then it might be time to be a bit more cautious in the kinds of investments we take on. From our previous example, maybe we should be looking at less NASDAQ rather than more.

It’s also interesting to note how fickle the Fear & Greed index can be (scroll down on the CNN page to see the index over time) as it flips from one extreme to another in mere weeks.

That’s why it can be so valuable to get this insight into where the herd is heading so you can make more objective and less emotional decisions about your own portfolio. If you’re approaching retirement, for example, and the index is pointing to “greed,” then perhaps it’s time to take some of your chips off the table. Similarly, if you’re young and want to take an aggressive approach to your portfolio, a time of “fear” could represent a great time to add more stocks to the mix.

I would add a word of caution that the Fear & Greed Index is not, by any means, a way to “time” the market. However, it is something that can help shape better conversations and more effective decision-making when it comes to your financial health.

Next time your instincts are telling you to act in times of panic or euphoria, the Fear & Greed of other investors may provide some valuable context to prevent emotions from taking over your decisions.