What It Means to “Be Fearful When Others Are Greedy"

The world’s most successful investor, Warren Buffett, once wrote in his annual letter to his company’s shareholders that if investors insisted on trying to time their participation in the market, they should “be fearful when others are greedy and greedy when others are fearful.” This is now an extremely famous quote and one of my favorite pieces of investment advice.

But what does it mean to average investors like you and me?

As a group, people tend to get “greedy,” or excitable and spend-happy in the market, when stocks are doing extremely well. After all, how long could you really wait to jump in if you saw stock after stock shooting upward in value and fattening the portfolios of investors who had already made the leap? According to Buffett, if the watercooler talk is all about buying more shares and the media outlets are saying buy buy buy, to be successful you need to be fearful.

This is because the market fluctuates. History tells us it will crash again – and that’s okay. This is where the other side of Buffett’s quote comes into play. You know it’s time to buy up stock and get greedy when everyone else is panicking because the market is down, because there might be a double-dip recession, because the stock market will never recover.. etc, etc.

But we all know that’s not true. Historically, what goes down must come up, and this is exactly why you will succeed by being greedy while others are fearful. Imagine if you had some money to invest in the beginning of 2009. The market had just tanked in 2008 and everyone was scared to death. Stock prices couldn’t go much lower, so you could take advantage and round up quite a nice portfolio.

Let’s say you were one smart investor, and tuned out all the noise. You ignored the doom-and-gloom media reports, the talking heads on TV, your coworkers who were devastated over their ruined portfolios. You stayed the course and held what you bought, and in the meantime, the market slowly recovered. Your stocks rose and rose in value until 2013 – when they returned an average of 30%! Now it’s time to balance your portfolio by selling off some of that very expensive stock and getting into some bonds. This is how successful investing is done!

In practice, being fearful when others are greedy and greedy when others are fearful looks like buying low and selling high. You should buy into stocks when their values are low, and you should sell them once those values are high. Putting it this way, it seems really obvious: of course you’d want to buy stocks at the lowest price and sell them when they are worth the most. But it’s a surprisingly hard thing for most investors to do.

This is because in reality, when stock prices are low, it means the market as whole is down and your portfolio may even be losing value. It can be very difficult to convince your risk-averse brain to throw more money into the market in this situation. Similarly, it can be hard to let go of stock that is on fire and hugely valuable. But if you do this consistently with your portfolio in a process known as rebalancing, over time your returns will be better than if you buy into over hyped assets that are likely to tank in value, refuse to let go of high-value stock, or if you fail to buy into stocks when they are cheap.

Rebalancing is just what it sounds like. Periodically, you take a look at your asset mix within your portfolio. Let’s say you started out with a mix $5,000 in stocks and $5,000 in bonds – or 50% stocks and 50% bonds. Since we’re currently in a bull market, your stocks have shot up in value. Your portfolio now has $7,000 worth of stocks and retained $5,000 in bonds. But your asset mix is out of balance now, since you have 58.3% in stocks and 41.6% in bonds. To rebalance, you would sell high and sell off some of your stock, and reinvest your earnings into bond funds. It works in reverse, too: when we experience another bear market, you may find that you’re holding too large a percentage in bonds. That’s when you buy low and invest more in stock.