In the modern age of information overload, one particular emotion has gained prominence in the world of finance: the fear of missing out (FOMO). This fear often drives investors to make impulsive decisions, sometimes to their detriment. In this episode, we will explore the psychology behind FOMO in investing, its potential consequences, how to manage it effectively, and when you should have FOMO.
Understanding the Fear of Missing Out
The fear of missing out, or FOMO, is a psychological phenomenon that refers to the anxiety or unease people feel when they believe others benefit from opportunities they are not partaking in. In the context of investing, FOMO often manifests when investors see others making substantial gains in an investment and fear that they are missing out on those gains.
A few key factors fuel FOMO:
Social Proof: People tend to look to others for guidance, especially in uncertain situations like investing. When they see friends, family, or colleagues making money in the market, they may feel pressured to follow suit.
Information Overload: With the advent of social media and financial news platforms, investors are bombarded with information and real-time updates. This constant stream of data can amplify feelings of FOMO as investors fear they might overlook crucial opportunities.
Regret Aversion: Investors are often more afraid of missing out on a winning investment than they are of losing money. This leads to impulsive decisions driven by the desire to avoid future regret.
The Consequences of FOMO in Investing
While FOMO can rarely lead to positive outcomes, such as taking advantage of lucrative investment opportunities, it more often results in negative consequences:
Herd Mentality: FOMO can lead investors to follow the crowd, causing them to buy assets at inflated prices. When the bubble bursts, losses can be significant.
Emotional Decision-Making: FOMO-driven decisions are often emotionally charged and impulsive. Emotional investing can lead to costly mistakes and a lack of a well-thought-out strategy.
Overtrading: Investors gripped by FOMO may constantly buy and sell assets, racking up transaction costs and potentially incurring short-term capital gains taxes.
Managing FOMO in Investing
Remember, a specific type of investing FOMO is good. We’ll get to that. But first, how do you manage the bad kind? To navigate the world of investing without succumbing to FOMO, consider the following strategies:
Set Clear Goals and Strategies: Establishing clear investment goals and a well-defined strategy can help you focus on your financial objectives rather than chasing the latest trends.
Diversify Your Portfolio: Diversification spreads risk across established sectors, reducing the impact of any single investment’s performance. This can mitigate the fear of missing out on a single “hot” asset.
Stay Informed but Discerning: Being informed is crucial, but filtering out noise and hype is equally important. Carefully evaluate information sources and remember that not every opportunity is as golden as it may seem.
Have a Plan and Stick to It: Develop an investment plan that aligns with your risk tolerance and long-term objectives. Commit to sticking with your plan, even when FOMO tempts you to deviate.
Avoid Impulsive Decisions: Before investing, research, analyze, and consult with your financial planner. Avoid making decisions in the heat of the moment.
Mental Discipline: Train yourself to recognize and manage emotional responses. Regularly assess your investment decisions to ensure they are driven by rational thinking rather than fear or excitement.
Required Fear of Missing Out in Investing
As promised, there is a good kind of FOMO in investing. In fact, if you want to be a successful long-term investor, you must have a certain type of FOMO.
Up to this point, we’ve been trying to avoid missing out on speculative fads. Everyone else seems to be getting rich on Bitcoin, the ARK Fund, or this or that. We fear missing out on these gains, so we jump on the bandwagon. This is bad.
But what about those of us who already have a diversified equity portfolio driving a plan to reach a goal? How can FOMO help us? Here it is.
To be a successful investor, you must have the fear of missing out on the next 100% advance in the value of your co-owned companies.
Let me tell you a quick story.
The Greater Fear
The Great Recession bottomed out in March of 2009. From January 2009 through December 2015, the S&P 500 gained 120%.
2016 was a contentious election year. After seven years of increases, many people thought we were due for another market drop. They feared missing out on keeping their current balances. They went to cash and bonds to preserve their money.
In the next seven years, from January 2016 through December 2022, the value of the S&P 500 grew 106%. Folks who feared another 20-25% temporary decline in the value of their equities missed out on a 100% permanent advance.
Two quick side notes on this story:
- For those seven years, the S&P 500 went up 134% with dividends reinvested. We will focus only on the price since price volatility is what we see and feel.
- This period ends in 2022, a down year. It only took five years for a 100% advance, reaching it at the end of 2020 (98% up). It then kept going in 2021 before resetting in 2022. Using 2016-2022 allows us to avoid using peak ending years. But I’m excited to see how this turns out over 2023.
Harness Your Fear
It is very natural to fear a 20% decline in the value of our equity portfolio. Part of being a successful investor is realizing that 20-40% declines are as common as dirt. It’s also natural to have fear in investing. Rather than trying to stifle our fear, let’s aim it in the right direction:
Thus, a crucial component of the investor mentality we must adopt is this: We must fight the fear of being invested through a 25% loss with the fear of missing out on a 100% gain.
The fear of missing out in investing is a common and potent emotion that can significantly impact financial decisions. While FOMO can lead to opportunities, it can also result in impulsive and detrimental actions. By understanding the psychology behind FOMO, recognizing its consequences, and implementing effective strategies to manage it, investors can make more informed and rational decisions, ultimately improving their chances of success in the complex world of investing. Additionally, adopting the good kind of FOMO can increase your success chances. Remember that successful investing is a marathon, not a sprint; avoiding bad and adopting good FOMO is a critical part of that journey.