A Lesson from "The Oracle of Omaha"
We would be remiss if we discussed
the topic of not getting caught up in the latest craze without mentioning a
very successful investor who stuck to his strategy and profited greatly. Warren
Buffett showed us just how important and beneficial it is to stick to a plan in
times like the dotcom boom. Buffett was once heavily criticized for refusing to
invest in high-flying tech stocks. But once the tech bubble burst, his critics
were silenced. Buffett stuck with his comfort zone: his long-term plan. By
avoiding the dominant market emotion of the time - greed - he was able to avoid
the losses felt by those hit by the bust. (Interested in what companies Warren
Buffett is buying and selling? (Check out Coattail Investor, a subscription
product tracking some of the best investors in the world.)
Greed's Influence
So often, investors get caught up in
greed (excessive desire). After all, most of us have a desire to acquire as
much wealth as possible in the shortest amount of time.
The internet boom of the late 1990s is a perfect example. At the time
it seemed all an advisor had to do was simply pitch any investment with a ".com"
at the end of it, and investors leaped at the opportunity. Buying activity in
internet-related stocks, many just start-ups, reached a fever pitch. Investors
got greedy, fueling further greed and leading to securities being grossly
overpriced, which created a bubble. It burst in mid-2000 and kept leading indexes depressed
through 2001. (For more on the dotcom bubble and other market crashes, see Greatest Market
Crashes).
This get-rich-quick mentality makes
it hard to maintain gains and keep to a strict investment plan over the long
term, especially amid such a frenzy, or as the former Federal Reserve chairman,
Alan Greenspan, put it, the "irrational exuberance" of the overall
market. It's times like these when it is crucial to maintain an even keel and
stick to the basic fundamentals of investing, such as maintaining a long-term
horizon, dollar-cost averaging and avoiding getting swept up in the latest
craze.
Fear's Influence
Just as the market can become
overwhelmed with greed, the same can happen with fear ("an unpleasant, often
strong emotion, of anticipation or awareness of danger"). When stocks suffer
large losses for a sustained period, the overall market can become more fearful
of sustaining further losses. But being too fearful can be just as costly as
being too greedy.
Just as greed dominated the market
during the dotcom boom, the same can be said of the prevalence of fear
following its bust. In a bid to stem their losses, investors quickly moved out
of the equity (stock) markets in search of less risky buys. Money poured into
money market securities, stable value funds and principal-protected funds - all
low-risk and low-return securities.
This mass exodus out of the stock
market shows a complete disregard for a long-term investing plan based on
fundamentals. Investors threw their plans out the window because they were
scared, overrun by a fear of sustaining further losses. Granted, losing a large
portion of your equity portfolio's worth is a tough pill to swallow, but even
harder to digest is the thought that the new instruments that initially
received the inflows have very little chance of ever rebuilding that wealth.
Just as scrapping your investment
plan to hop on the latest get-rich-quick investment can tear a large hole in
your portfolio, so too can getting swept up in the prevailing fear of the
overall market by switching to low-risk, low-return investments.
