Over my many years in the Investments Industry, I have witnessed investment decisions that were brilliant and others that were borderline insanity. If I had to label all the decisions I have observed under one human description, it would probably fall under “human emotion”. What do I mean by that? There are two human emotions that normally take over the mindset of an investor prior to making a financial decision. These two emotions are “fear” and “greed”. Neither emotion is necessarily good or bad, but they play a very large part in the decision making process. Over the past decade there have been two prime examples of each of these emotions.
Beginning in the early years of the 2000 generation after Y2K, real estate investing became more and more popular. This was particularly true for investments in retail real estate such as single family homes. One of the reasons for this popularity was the easy access to borrowing money. Up until this point in history, someone wishing to make an investment in a single family home would be required to put down 10-20% of the purchase price in cash, prior to closing on the sale. But as the years 2003-07 came upon us, those old rules seemed to fade away. Borrowed money became more and more accessible and cash down payments on single family home purchases became a thing of the past. Nearly anyone could not only borrow 100% of the purchase price of a single family home, they could often get a mortgage in excess of the purchase price that would allow them to add new furniture to the home and a new automobile in the garage. Why did this happen? The reasons for what happened are controversial. Some blame politicians for wanting every American to have the opportunity to become a homeowner, regardless of their ability to make mortgage payments. Others blame the banking system for authorizing mortgages for people who almost certainly had no ability to repay. Still others blame Wall Street for purchasing all of these mortgages that were doomed to fail and packaging them into securities (sub-prime securities) and then reselling those securities all over the world. In my opinion, they were all to blame and all responsible for the collapse that followed. What does this have to do with emotion?
I am the proud father of two boys. At the time of this real estate mania in the early-to- mid 2000s they were both in their 20s and both had investment funds available. Both boys had numerous friends that were purchasing multiple real estate properties with no down payments in cash on any of the properties. They would buy single family homes, borrow 100% or more to close on the properties and then put the properties on the market for resale at a higher price. Some of their friends had as many as 10 properties at a time. In most cases they were able to resell the properties at a higher price and their business was booming and their profits soaring. Thus, they had entered the world of greed. They were gambling with money they didn't have in a business they knew they couldn't afford. My boys wanted to do the same and become real estate tycoons. Fortunately for them, they listened to their father. I warned them and I warned their friends that this was an accident waiting to happen. This was not how the financial markets work. I warned their friends that the only possible end in site for them was bankruptcy when the ultimate collapse were to come. As it turned out when the collapse did come it was even more severe than I had anticipated. And yes, most of their friends declared bankruptcy. This was the pure definition of greed in the lives of investors.
As a result of the real estate crash that began in 2007-08 when people began to default on their mortgages, the economy slowed down dramatically. This was not only true in the United States where all of these mortgages on homes existed, but all over the world as a result of the sub-prime securities that Wall Street had created and resold. There was no geographical limit to the sale of these securities. Financial markets began to collapse. Liquidity in the banking system disappeared. Lines of credit were cancelled. Access to capital for the average person was gone. The only way to get money was to sell anything at any price. Investors watched in horror as their stocks plummeted in value. They watched their 401(k) and other retirement accounts drop in value 40-50-60% and they became panic stricken. Just a couple of years after the “greed” emotion disappeared from the investor marketplace, we had now entered the “fear” emotion in full throttle.
As an Investment Advisor it was now my full time job to try and stop the fear emotion from taking over the lives of investors. Most investors listened to me and stayed the course. I advised them that my retirement accounts were also experiencing severe declines, but I wasn't selling. America is the greatest country in the world and our markets will rebound. Have faith. Unfortunately, fear took over the emotional characters of some investors and they liquidated all their stocks and retirement accounts right at the bottom of the market in 2009.
Before making an investment of any kind, the primary objective must be a clear and open mind. Can I afford this investment? Think of what happens if everything goes wrong. Hope for a successful investment but be prepared for the unsuspected. Don't buy because everyone else is buying and don't sell when everyone else is selling. Be your own person under control.
Eliminating fear and greed from your profile as an investor will not only make you a better investor, it will make you a profitable investor too.