In its essence, the saying represents the quintessential core of what it means to be a contrary investor. It’s a matter of zigging when everyone else is zagging, and zagging when everyone else is zigging.
That’s a disciplined strategy all its own, and one that very few investors master. So if this advice is so counterintuitive, why should we master it at all?
Investing's relentless emotional “X” factor
Emotion is a greatly underestimated investment factor. But the stock market is actually controlled by the two emotions of fear and greed.
Greed is largely what powers bull markets, while fear is mostly what drives bear markets. The intensity of either emotion is magnified in the most extreme examples of either a bull or bear market.
Given that the two emotions are such important market drivers, successful investing requires that we master control over both. The market at large will experience both greed and fear — but what’s most important is that we never give in to either.
Successful investing requires keeping absolute control of our own emotions, no matter what is happening in the big picture.
Be fearful when others are greedy…
As mentioned, greed is a major component of bull markets. People pour into the market — with ever-increasing amounts of money from whatever source — in hopes of getting rich. In the strongest of all markets, it can often seem as if fear has taken a holiday.
In fact, if there is any fear evident in the market at all, it’s fear of missing out on the market’s next leg-up. Buy on the dips, any news is good news, ignore the naysayers — just buy, buy, buy!
But the first half of Buffet’s statement implies that such a market is exactly the type we need to sit out. Common sense has left the building and greed has taken over — that’s your cue to leave.
Others are greedy, and that means we need to be fearful, stop buying, and start paring back on current holdings. This is the time to be raising cash.
You’ll need the cash when fear takes over.
…be greedy when others are fearful
The second half of Warren Buffett's quote is the one that’s generally more difficult to master. But when everyone else is running scared, that’s the time to be an optimist, to be ready — with cash — to buy up the investments that others are dumping.
Investor confidence is tanking, and even the talking head experts are having difficulty finding anything good to say about the market.
It's in this kind of environment — where fear is ruling the day — that investments of all kinds go “on sale“. It's the perfect time to buy bargains that will produce the biggest potential gains possible.
But the reason so few people are as successful and wealthy as Warren Buffett, is because of the inability to cast out fear and move forward at a time when everyone else is panicking.
The typical investor buys heavily at market tops, and then sells at or near market troughs. This is the perfect recipe for investing disaster.
You are buying stocks at premium prices — simply because that is what the herd is doing — and then you’re dumping them at the bottom, locking in your losses forever.
How much more successful an investor could you be, if you could resist the temptation to buy when everyone else is buying, and to sell when everyone else is selling? In theory, it seems easy enough to do, but in reality, it can take nerves of steel.
Do you have them?
Dealing with the trends and the news clutter
Carrying out Buffett's investment philosophy would be difficult enough if it were simply a matter of mastering your own emotions. But our emotions get a big assist from the market at large, as well as from the media.
In rising markets, the herd is buying. The media is recommending buying, and a contrarian voice is completely ignored. In fact, both investors and the media prefer that such types quietly go away. In this kind of market, sitting out (or selling off) can give you a distinct feeling that you’re missing the party.
In falling markets — especially those dropping in epic proportions — there isn’t an optimist to be found. Investors are heading to the exits en masse, and the news media is proclaiming doom and gloom. The thunder of negativity can cause you to doubt your own instincts.
If you’re going to put Warren Buffett's investing advice into practice, you need to find a way to block out all the background noise. As human beings, we have that herd instinct thing going on, and it's absolutely toxic to successful investing.
Are you ready to put Warren Buffett's investing advice into practice?