Fear and greed
The two strongest forces in the market don't appear on any chart. They sit in your head and make people often buy high and sell low.
Learning objective: After this lesson you'll recognize how fear and greed distort your own buying and selling decisions.
When everything is rising and it's reported everywhere, buying feels safe. When everything is falling and panic reigns, selling feels sensible. Exactly the opposite would be right.
Why the Brain Reacts This Way
That's not a character flaw. It's how our brains are built. They want to join the group and avoid danger. That used to save lives. On the stock market it costs money.
Deciding in Advance
That's why resolving to stay calm doesn't help much. In the moment of panic no resolution holds. What helps are decisions you made beforehand, when things were calm.
In practice that means a savings plan instead of individual buying decisions. Fixed rules instead of how you feel on the day. And a note for emergencies that says what you'll do in a decline. Hanna wrote on hers: I'm not selling anything as long as my plan hasn't changed. In March 2020 she read the note three times and sold nothing.
Behavioral research explains this with two ways of thinking. One is fast, automatic and driven by feelings. The other is slow, deliberate and calculates. Under time pressure, uncertainty and excitement, the fast one wins. A stock market crisis brings all three at once.
Money Flows in Funds
You can measure this in money flows into funds. After good years a lot of money flows in, after bad ones it flows out again. Because strong phases are often followed by weaker ones and vice versa, this creates a lasting gap between the funds' returns and their investors' returns.
Safeguards Against Panic
Precautions that take the decision out of the heated moment work best: automatic savings plans, fixed dates for rebalancing, written rules for your portfolio. They work because they take away your option to act. The feeling is still there. It just doesn't do any damage anymore.
Summary
- Buying feels best when it's most expensive.
- Resolutions don't hold in a panic, automatic routines do.
- Write down your rules while things are calm.
Did you get it?
Why don't good resolutions hold in a crisis?
Because under uncertainty, time pressure and excitement, fast, feeling driven thinking wins.
What is the return gap for fund investors?
Investors earn less than their own fund because they buy after good times and sell after bad ones.
Why do automatic savings plans work?
Because they take away your option to act instead of asking you to master your feelings.
Check your understanding
Your task
Write your own note for an emergency. State what you will do if your portfolio falls 20 percent, and work out beforehand how many dollars that is on a $15,000 portfolio. Then play through the crash test and see whether you would stick to your note.
Sources and further reading
- Morningstar's annual Mind the Gap study: over the ten years through the end of 2024, the average dollar invested in funds and ETFs earned about 1.2 percentage points a year less than the funds themselves, due to poor timing. View source ↗
Related
- Why prices moveStage 1
- The classic beginner mistakesStage 1
- Risk-reward ratioStage 3
- Matching questions for this stageQuestions