The fear of missing out on the latest hot investments is a primal emotion that can play havoc with investment portfolios. The irrepressible urge to keep up with the Joneses infects financial markets just as it pervades daily life.
We yield to temptation to check out today’s trendy restaurants or pay big bucks to catch a hit Broadway show or to buy the coolest new smartphone or designer clothes.
What are the dangers of succumbing to market FOMO?
The dangers of succumbing to market FOMO can be more consequential than those of paying for an overpriced dinner. An impulse to jump on the bandwagon can lead to buying at inflated price points, which goes against the grain of the cardinal investing principle: Buy low.
Piling on risk, the current infatuation with social media — much of which is pure gossip — exacerbates trends and puts FOMO on steroids. Think meme stocks like GameStop, trading apps like Robinhood and the general concept of cryptocurrencies, all of which lurch up and down with wrenching volatility.
A famous story illustrates how investors get caught up in the frenzy of a FOMO bubble. It is said that John D. Rockefeller unloaded all his stocks in 1929 shortly before the crash after hearing market tips from his shoeshine boy.
Situations like this could entice other people to follow suit because they fear missing out on the luck someone else is experiencing. However, good fortune for one person doesn’t necessarily mean the same for everyone else! It’s all relative, which FOMO can cause us to overlook.
FOMO: Then and now
History is an instructive reminder. Before rushing to commit your hard-earned money to richly priced markets at the wrong time, remember where we come from. We are already 13 years into a bull market that started after the Great Recession in 2008.
Plus, the beast is getting long in the tooth. Looking back a couple of years, namely after the months when COVID-19 first struck back in 2020, the capital appreciation of stocks feels like a windfall.
Investors are especially vulnerable to market tops and bottoms, as this is when emotion is particularly capable of overwhelming rational thinking. In fact, it may take years to recover from mistakes made during those periods.
For instance, after the dot-com crash of 2000, technology stocks fell by 77%, collapsing the Nasdaq from 5,048 to 1,139. The index failed to regain that ground for 15 years, meaning it remained at a low point until April 2015.
Fast-forward to the present day. In 2022, the cyclically adjusted price-to-earnings ratio, which was popularized by economist Robert Shiller, stands at an eye-popping 35.5, which is 50% above its long-term average. This level has not been reached since the dot-com boom.
In other words, the air is thinner up there, but that is not a license to “time” the market. Historical overvaluation can persist for a stubbornly long time, making FOMO investors increasingly frustrated and ultimately more reckless.
Disciplines for managing FOMO
It can be challenging to harness basic behavioral biases and instincts that are deeply rooted in fear and greed. However, a number of strategies may help investors resist the FOMO siren song:
- Do research. You should be able to express a valid reason for making an investment. Somebody else’s secondhand recommendation is not good enough.
- Keep positions modest. You can add to them later.
- Maintain your trading strategy. Whether you commit to value, diversification, dividends, risk management rules or other financial philosophies, don’t stray off course.
- Find a friend or family member to talk it through with. If you can’t clearly explain why you want to buy, maybe you should reconsider.
- Impose built-in discipline. Rope yourself to the mast. Consider using unmanaged exchange-traded funds or a robo-adviser for some of your portfolio.
- Invest in multiple asset classes. If possible, invest in bonds, real estate and mutual funds as well as equities, which makes for diversification.
- Take a long-term approach. How would you feel about a 20% correction? What if today’s plum investment that feels so promising right now went down by 30%? Consider the possibilities and then act accordingly.
- Wait. Take a breath. Sleep on it.
Even after you have conducted all these exercises, consult your financial adviser before you take a position. A neutral, professional opinion can save you from falling into the traps of costly stumbles.