Thursday, February 23, 2006

Fear is Your Friend: Embrace It!

The other day I entitled an article “Fear: an Investors Biggest Friend & Worst Enemy” and it occurred to me that I’d said why it was an enemy, but didn’t say why it was a friend. The reason is, if you learn to use your fear – which generally occurs after an extended market decline – as a contra-indicator.

In other words, you recognize the fear, but also recognize that a market decline generally represents an excellent opportunity to increase your long-term rate of return. I’d read that an analysis determined that if you added 10% to your stock portfolio after every 20% market decline (an opportunity that admittedly doesn’t happen very often), that you would increase your overall rate of return by 2% annually.

While 2% doesn’t sound like a lot, it has large implications over a long investment horizon. For instance, if you think your return rate is likely to mirror the long-term average of the stock market (large stocks: 10% or so), then increasing your return by 2% annually means this over a 25 year period:

Instead of a $100,000 portfolio being worth under $1.1 million in 25 years, it is instead worth over $1.7 million. What a huge difference when using fear to your advantage.

So this is how to turn fear to your advantage – by using the Warren Buffett saying … “We seek to be greedy when others are fearful, and fearful when others are greedy.”

Fear – your best friend.


The Confused Capitalist

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