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globalsailor (35.05)

What does "Be greedy/fearful" really mean?

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October 15, 2009 – Comments (0) | RELATED TICKERS: BRK-A , BSV , HCN

How should you be greedy when others are fearful but fearful when others are greedy?  Manage your risk.  Have a certain percentage of your portfolio in large caps, small caps, preferred stocks, bonds, precious metals, real estate and everything else.  (Obviously make sure that it's all good stuff that's going to appreciate).  When the percentages become messed up correct them.  That way when it's down you buy more and when it's up you sell more.

As an example let's say you have security A (a small cap stock) and security B (a short term bond index fund).  You decide you are going to buy $10000 of each (each one costs $10 so 1000 shares) because you want 50% exposure to bonds and 50% exposure to small cap stocks.  Assume that over the next few days of this scenario the price of our bond stays constant.  Finally assume that your target price for A is $15 and you won't sell it until then.

Ready?

Day one:

A drops from $10 to $8.

total $ in A = $8000 (1000 shares); total $ in B = $10000 (1000); $0 cash

Here's the greedy part: sell 100 shares of B and buy 125 shares in A.

total $ in A = $9000 (1125); total $ in B = $9000 (900);

 

Day two:

A gains $4 and goes from $8 to $12.

total $ in A =  13500 (1125); total $ in B = 9000 (900);

Now here's the fearful part: sell 188 shares in A; buy 225 shares in B

total $ in A =  11244 (937); total $ in B = 11250 (1125);$6 cash

 

Day three:

A loses $2 and goes from $12 to $10.

total $ in A = 9370 (937); total $ in B = 11250 (1125); $6 cash

TOTAL: $20626 (A three percent gain on two FLAT securities)

 

Okay, obviously that was an insane ride that would rarely ever happen in three days, but it might happen over the course of a liftetime (or sometimes a year).  For this exercise we had to believe that no matter what the market thought, A and B were good securities and were going to make money. Furthermore, we played our hand right, and as A went through it's ridiculous cycles, we leveraged our gains when it went down and took our profits when it went up.  This is what it really means to "Be fearful when others are greedy and greedy when others are fearful".  Don't let your personal/market psychology get in the way of your investing.

While picking the right company is a subjective task, deciding how much to allocate to it should be based on hard numbers that your emotions can't mess with.  Don't listen to what the market thinks about your security because the market is impossible to understand.  Just know how to value your company.  Also if you think that now is not the right time to buy a type of security remember that the world never ends, there is always a bright spot, and the good investor will find it (even in real estate).

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