Financial markets are driven by emotions: Fear and Greed

“Master your emotions or they will master you.”

Fear is a strong primal and instinctual emotion. Fear has kept our species from getting eaten by saber-tooth tigers and jumping off cliffs trying to fly like a bird. 

Greed is also a primal emotion. Greed has forced our species to excel and thrive. It is also the source of conflict when one persons greed overlaps with another’s.

While we may like to think we have evolved beyond our primal instincts, our emotions are still very primal. The stock and bond markets which are a major source of wealth in the global economy are primarily driven by these two primal emotions: fear and greed.

Investing is scary and at the same time alluring as a potential source of wealth. Whether you are new to investing or a seasoned veteran, you will constantly battle both emotions. You will also have to learn to cope with this psychological impairment if you want to learn to invest better.

Some of the world’s most successful investors have learned certain tricks to cope with these emotions which would impair an otherwise rational investor. In order to become a successful investor, you will need to understand these two emotions and how to harness them in a productive manner.

Fear tends to be the strongest emotion and also the most elusive. Primarily because investors don’t understand how it applies to their own investing psychology. Let me elaborate…

?Fear: The 2 fears of investing

The emotion of fear when investing can be broken down into 2 sub-categories: Fear of losing money, and fear of under-performing the market (or more commonly known as, the fear of under-performing your friends).

 

Everyone is familiar with the fear of losing money. Whether it is money which was lost by falling out of your pocket, lost at the poker table, or lost by investing in a bad investment, unless you have an endless supply of money, everyone understands this fear.

The second part of fear is often overlooked. I see it every day in people I meet. The second part of fear is the fear of under-performing, or not doing as well as your peers. While this should be rather irrelevant to a rational person, the drive to compete or “fit in” with one’s peers, often overpowers a person’s better judgment. This feeling could also be described as “keeping up with the Joneses.”

This fear causes people to buy big houses (that are much bigger than they need), buy expensive cars (because they can afford the “payment”), buy boats, and other expensive items. This also causes people to buy tech stocks in 2000 because, despite that fact that many of these stocks didn’t make money, you didn’t want to miss out on the opportunity for “easy money”. This also happened in 2005-2008 when the housing boom had peaked, but people kept buying as many homes as they could to take advantage of the housing boom.

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