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Investor emotions part 1: Greed

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“Working nine to five, what a way to make a living”, sang Dolly Parton. She was right, too, although today it’s more like “Working nine to six with a twenty minute lunch break, plus the commute, and probably an hour’s unpaid overtime on top and I never get any thanks and my blood pressure’s too high and my back’s killing me and… what a way to make a living.”

Either way, working for other people is, on the whole, not the surest route to early retirement on a yacht anchored in the sky-blue waters of the Med.

What are the alternatives? Well, you could start your own company (which is hard work), rob a bank (which is not without certain legal and ethical risk), take up gambling on the horses / dogs / boxing / whatever takes your fancy, or you could start investing. The latter two – gambling and investing – might appear to the uninitiated to be rather similar. In the most crucial ways, though, they are in fact exactly the same:

1) The only person who makes money all the time is the bookie / broker
2) It is entirely possible to lose all your money through gambling / investing
3) The shrewd, experienced gamblers / investors tend to make money at the expense of the gullible newcomers

None of which stops people trying to take a short-cut to riches through investment, as the recent Northern Rock débacle has shown. At the time of writing the NRK share price is hovering around the 200p mark, but fluctuating wildly with far greater volatility than the rest of the market; sufficiently so for some observers to be calling for the shares to be suspended.

All this volatility is being generated by speculative investors, as they are known; or gamblers, as they should be known. And these people are driven, naturally enough, by greed. Judging by some of the visitors to investment forums over the last few weeks, the decision process went something like this: “Here, Dierdre, that bloke next door said he put five grand on Northern Rock and doubled his money in a coupla days. Hand me the kids’ piggy bank and our life savings – I’m off to the broker.”

It’s an appealing notion. After all, if you had bought NRK at 150p, say, and sold at 250p in the space of a few days, you could have made a fortune with a large enough stake. Similarly, if you had thought that bad news would drive the shares down earlier in the year, you could have ’shorted’ them (sold the shares at a high price to buy them back at a low price, pocketing the difference) from 700p down to 200p, making even more.

Note the two most important words in the previous paragraph: ‘if’ and ‘could’. These words are often conveniently overlooked by amateur investors, who get a ‘gut feeling’ or believe that ‘the government would never let the share price go any lower’ or ‘it said in the paper that the shares are now undervalued’ or ‘everyone’s buying so they have to go up’ or any number of other reasons (i.e. excuses) for piling into the market in the hope of making a quick profit.

“If we had a time machine, we could go back and make a fortune.” Well yes, we could. But we don’t have a time machine. And there’s no telling for sure which way a particular share will go; up or down. You can, in some cases, make an educated guess based on all the information available to you. Some of the time you’ll be right, some of the time you’ll be wrong. What separates the professional investors from the amateurs is how much it hurts when things go wrong – and one of the things that determines that level of hurt is greed.

If you knew, without a doubt, that a certain investment was a dead cert, couldn’t fail, 100 percent guaranteed… you’d put a lot of money on it, wouldn’t you? That’s exactly what speculative investors tend to do. Greed makes them gamble more than they can afford to lose, in the belief that they won’t ever lose.

The problem is that no investment is a dead cert, can’t fail, 100 percent guaranteed. Most are very far from being so. The words “the value of your investment can go down as well as up and you may get back less than you invested” on investment products and services aren’t there just for show; down is just as likely as up for any given share you can name. With a sensible stake you can walk away from your loss if the market moves against you. But if you pile in, all or nothing, you stand an excellent chance of losing your money and your pride.

Here’s a simple rule of thumb to follow when deciding whether or not you’re being greedy: if you’re expecting to make more than 15-20 percent profit in a year (which is enough to double your money in four to five years, compounded), you’re probably underestimating your true risk level and stand a serious chance of coming a cropper due to greed.

And furthermore, when deciding how much money to ‘invest’ in a particular share or market, ask yourself how you’d feel if you drew the same amount of money out of your bank in used £20 notes and set fire to it. If the answer is ‘annoyed’, then you’ve probably got the stake about right. If the answer is along the lines of ‘distraught’ or ‘destitute’, then you’re being greedy. Reduce your stake, put the rest back in the bank and start again. It’s better to get there slowly than not get there at all.

Greed may be good (according to Gordon Gecko in the film ‘Wall Street’) when playing with other people’s money, but it’s downright stupid when gambling or investing with your own hard-earned cash.

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