six Strategies to Manage Money, Fear and Greed

This has been an interesting week. As I write this post on Thursday the stock markets are melting down. The Dow Jones Industrial Average is down over 1,000 points and the S & P 500 is down 4.20%. However, yesterday the stock market averages hit all time records. This week illustrates the constantly competing emotions that clamor for our attention when the stock markets are jumping.

Another way to express the two emotions of fear and greed are the “fear of missing out“ and the “fear of being in.”

If you were invested in the market in March, you probably felt a little of the angst that comes from the “fear of being in” the market in the midst of a significant correction. I know several people who felt this fear and cashed in all their market investments and went to cash. But, of course, that temporary relief quickly turned to the “fear of missing out” as the market has roared to new heights in just a few months.

Benjamin Graham was an economist who came up with an allegory called Mr. Market to help us understand the wild fluctuations in the stock market and to help us take advantage of them. In short, Mr. Market is a manic-depressive whose estimates of the value of the stock market can vary day to day from wildly optimistic to very pessimistic.

If Mr. Market were our neighbor, we could take advantage of him.  If we reasonably thought the value of our house might be $300,000, we would have no trouble turning Mr. Market down on his extremely moody days when he offers us $150,000 for our house. However, on days when Mr. Market is upbeat and singing how good the world looks to him and offers us $600,000 for our house, we might be willing to sell.  

The house example is an easy one for us to relate to because most of us have a good idea what houses like ours are worth in our neighborhoods. However, the problem with the stock market is that not many of us are wise enough to know what the value of stocks we own might really be. Is Mr. Market overvaluing Apple stock after the incredible run it’s had?  I don’t know and I can find smart analysts who will argue the bull and bear case for that stock.

So, knowing that the market will fluctuate wildly, and our own limitations on valuing stocks, what are some ways we can be smart and also manage our fears in handling our 401(k)’s and other investments? Here are 6 strategies I’ve found helpful.

• I like to make my biggest holding a low-cost total stock market index fund because I know that as the market prices for technology stocks like Apple, Google, Microsoft and Facebook have soared, I have not missed out on that rise because they are a part of that index. It helps hold down on my “fear of missing out” if I know I own a piece of the hottest stocks.
• Financial advisors will always discuss risk tolerance with clients. It’s an abstract concept that tries to help us identify how we are wired to handle the inevitable downturn. I know that I could have been a lot richer today if I had been able to stomach keeping 100% of my money in the stock market the past 40 years. However, I like to sleep at night and have always tried to include a generous percentage allocation to cash and low volatility investments like insurance annuities and bonds. The market meltdown in March should have been a real time test for understanding if your own investments reflect your risk tolerance or not. Having enough cash on hand to ride out the down turns in the market help us deal with the “fear of being in.”
• Many of us have a circle of competence in some areas that might give us an edge in investing into a particular stock or industry. I keep my individual stock investments to less than 10% of my total investments, but it’s a low risk way to have a little money in an area we might actually have an edge on the market. My professional interest in community bank stocks gives me an edge in this area, but I still keep the percentage of my net worth invested in this space low in case I’m wrong.
• It’s almost never a good idea to put money into risky assets that you intend to use in the next five years because it’s not unusual for the total stock market to lose money over that time horizon. Retirement, on the other hand, usually takes 40 years of saving and investing. With that kind of time horizon and the historical track record of stock market performance, we have incredibly high odds to make money saving for retirement in the stock market if we stay invested. However, our risk of losing money in the stock market in a five-year horizon are too high for me to risk money I plan on using in that time period.
• To stay diversified, it’s important to remember that the stocks that are hot today, like technology, will one day cool off. Stocks that are lagging today, will one day be market leaders. In hindsight, I wish I had put all my money in technology the last few years because they have been on fire. But without the wisdom of 20/20 hindsight, the comfort of being diversified allows me to sleep better knowing I’m in the whole market and when it rotates, I will be in a good position to have some of the new winners working for me.
• Finally, if you look for advice on how to invest, you will eventually hear someone criticize long term “buy and hold” investing that I have been discussing so far. Instead, they will be trying to sell you on becoming a market timer investor. It’s not a bad idea in theory to invest as stocks are going up and sell when they start going down. It can be an effective way for some to deal with their “fears of being in or out” at the wrong time. However, it requires constant attention to the markets, can be cumbersome in execution and requires that you use good buy and sell signals, many times based on when the stock price crossing a moving average. I’ve tried this method with limited success, but if I wanted to wade back into this type of strategy, I would definitely limit my percentage exposure to no more than 20% given the challenges in succeeding and the good track record of long term buy and hold strategies.

I hope this is helpful to you in offering some ideas for your finances in a way that brings prosperity with the ability to sleep at night. I’d love to hear from you what has worked for you!

Joe Kesler

Founder, Smart Money with Purpose