(A Little) Greed Is Good When It Comes to Investing

Only a businessman's hands show as he pulls a pile of cash toward him.

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published 7 September 2023

There’s a certain appeal to being a contrarian investor. Zigging when others are zagging. Going against the herd. And when you’re proven right, it feels pretty darn good (and can pay off handsomely).

One of the first adages contrarian investors learn comes from Warren Buffett. In his 1986 letter to Berkshire Hathaway shareholders, Buffett wrote about being fearful when others are greedy, and greedy when others are fearful.

Such moments are easy to recall. Maybe you bought Bitcoin near its 2021 top, when fear of missing out (FOMO) was in full swing. Or you saw a huge opportunity to buy stocks in March 2020, during the COVID crash … but couldn’t bring yourself to pull the trigger.

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Those tops and bottoms burn into our memories. But when it comes to investing around them, there’s a problem: They are rare.

It’s been nearly 36 years since 1987’s Black Monday stock market crash. From that time period up until today, the United States has had five bull and bear market cycles. That means 10 days of tops and bottoms. Over 36 years.

How are we to invest the rest of the time?

It turns out, when others are greedy, being fearful can cost you. Big-time.

How investor sentiment has changed

This is particularly important to keep in mind today, because investor sentiment has dramatically changed compared to a year ago. One way to measure this is the American Association of Individual Investors (AAII) Sentiment Survey. Every week, the AAII polls individual investors about their sentiment on the market for the next six months. Investors can indicate whether they are bullish, bearish or neutral.

The chart below shows how bullish investor sentiment has changed over the past three years. The long-term average for bullish sentiment is 37.5% (the green line), so anything above that level could be considered more optimistic than usual.

There was plenty of optimism going around in 2021. There’s nothing like reaching new all-time highs to get investors feeling good about the stock market. The party ended in 2022, and naturally, investors were less enthused.

In hindsight, it’s easy to see that this is the exact opposite of how investors should have been feeling. They felt great when stocks were about to go over a cliff. Then they hated stocks right before the market was about to take off.

Is it time to look for the exits now?

When the market seems dismal, having perspective and keeping calm can be a huge advantage. In our mid-year letter to SAM clients in 2022, we noted that investors were unbelievably pessimistic, with AAII bullish sentiment at its lowest point in 30 years. Lower than the early days of COVID. Lower than the 2008 Global Financial Crisis. Lower than the bursting of the tech bubble.

We told our clients that “the type of market pullback we’re seeing today is what leads to big gains in the future.” That has proven to be correct. But how should investor sentiment be guiding decisions in today’s market?

The contrarian in you might be thinking that with investors feeling good about stocks again, it’s time to look for the nearest exit doors. But not so fast. Investors’ bullish sentiment over the past month has averaged 40.5%. That’s only a little higher than the long-term historical average of 37.5%.

In other words, investors are only a little greedier than usual. And it turns out, when investors are feeling just a little greedy, there are usually positive returns ahead.

Sure, you might do a little better if you buy when bullish sentiment is down in the dumps. But the reality is, it doesn’t happen that often. The market goes up more often than it goes down. And as mentioned, the market going up makes investors feel more bullish.

Bull markets often end when investors have reached a state of euphoria. Today, investors are slightly more optimistic than average. And there are still plenty of bull market skeptics!

We’re certainly a long way away from euphoria. Now is not the time to be fearful. Or greedy. As we’re telling SAM clients: Now is the time to stick to your investment plan. And if you don’t have a well-thought-out plan geared toward reaching your financial goals, there’s no time like the present!

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Michael is a Portfolio Manager and Deputy Chief Investment Officer at SAM, a Registered Investment Advisor with the United States Securities and Exchange Commission. File number: 801-107061. He sources investment opportunities and conducts ongoing due diligence across SAM’s portfolios. Michael co-manages SAM’s Income and Tactical Select strategies. Prior to joining SAM, Michael worked with high-net-worth private clients for the largest independent wealth management firm in the United States. He was also a senior analyst for one of the largest investment-grade bond managers in America. Michael joined SAM in 2017.