Most investors believe in healthy greed, and it seems like even people who haven’t seen the Oliver Stone movie Wall Street know that Gordon Gecko says that "greed is good." But this old chestnut warns us that we can get too greedy, whether we are long or short on the market.
Casinos make money because we tend to believe in things like 'luck' and 'streaks'. But winning five spins of the roulette wheel doesn't change the odds at all for the sixth spin. Our impulse to 'let it ride' when things are going our way is just a method of returning money to the house. Of course, most people enter a casino expecting to lose money. But in the stock market, investors tend to expect big winnings.
During the beginning of the 2000 bear market, the Institute of Psychology & Financial Markets released a study that said that one in five investors expect to get better than 20 percent a year in returns from stock investments. Vanguard founder John Bogle countered with a bit of reality, calling an 8 percent return realistic, with about 1 percent of that coming from div idends. An investor expecting to make 20 percent is bound to be disap pointed by reality, and that disappointment can inspire bad decisions.
One common investor reaction, when confronted with returns that don’t meet expectations, is to overreact and spend a lot of money trading old positions for new ones. This maneuver seldom does anything for returns, because even if the new stocks are better, the cost of buying them will wipe out the advantage. It’s important to be patient and not to panic at the sight of a reasonable return.
Investors on a winning streak are also at risk. There’s a tendency to equate stock market proficiency with genius. That’s dangerous in a game where the only thing that distinguishes real skill from luck is a long track record. A stock on a roll can be infectious because it seems like it will climb forever. That’s why it’s important to check in on highflying stocks every now and then and to make sure that the rise in price isn’t completely out of proportion to the company’s growth in sales or earnings. If it is, sell it. If it will pain you to watch the stock go up more after it’s sold, then force yourself not to type its ticker into a Web site ever again.
Bulls believe that the market is going up, and Bears believe it’s going down. Pigs believe that Wall Street is like the farmer with the slop bucket, on his way to pour vast amounts of money into a trough. But really, the only greed that is consistent is the greed of Wall Street professionals. Stock prices rise and fall, but brokers always get their fees.
By all means, invest to become rich. But don’t expect the money all at once.
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