Are we wired to fail at INVESTING?
In a word, yes.
by: David Cross, Certified Portfolio Manager
This is your brain
This is your brain on investing
Investing is part of life. How well you do it determines whether life’s stages and their associated costs are ushered in smoothly or with a lot of ups and downs. Contrary to what you may think, your thoughts about investing can have a significant impact on the success of your plan. Even though you may not be the advisor setting the strategies when it comes to your personal portfolio management, as part of the partnership, your decisions help shape your level of success, or lack thereof.
According to behaviorist Dr. Roger Hall, our brains are governed by two parts, the frontal lobe responsible for calculations and evaluations, and the amygdala which controls emotions, behavior and motivation. During times of stress, the amygdala hinders your frontal lobe so that you focus on survival. Although this fight or flight function is meant to ensure survival, it was not originally intended to aid in successful investment management.
It is important that investors understand the physiology of their brains because some serious mistakes can be made during times of stress.
The amygdala is responsible for the response and memory of emotions, especially fear. According to The Brain Made Simple, “when you think of the amygdala, you should think one word, fear. The amygdala is the reason we are afraid of things outside of our control.” The stock market is certainly one thing that you can’t control. In many cases, fear is compounded because of a lack of understanding.
Consider an investment scenario in which you invested $1 million dollars ($1M) with an investment professional. Market swings can range from negligible to substantial, and depending how closely you monitor your investments, you could see your balance decline rapidly. For instance, if you have $1M invested and a 10% decline occurred, the resulting loss of $100,000 can rattle even the most ardent investor.
Fluctuations in the market should be expected and are completely normal. Most investors think nothing of it when the waters are calm. However, when stormy seas cause waves, and the market is going up and down, those expected fluctuations send some clients’ sound reasoning and rational judgement right out the window. Your advisor’s strategy should be a comprehensive plan that takes these expected fluctuations into account regardless of short term volatility. The value an investment professional brings to the table is the ability to assess both short term and long-term valuations while balancing risk tolerance for each client’s situation in pursuit of their goals. But when the stock market declines, you might think that same professional you had all the confidence in had recently lost all ability to manage your investments. Sounds crazy, but that’s how our brains work. The brain’s fight or flight response demands immediate action and relief from stress at the expense of calculated reasoning and understanding.
To make matters worse, during times of stress, we naturally seek out leaders and authority figures for direction. Unfortunately, most people turn to the television or surf the Internet about what to do with their money. Knowing the media thrive on bad news, it’s no surprise that the loudest voices attract your attention. Between Jim Cramer’s frenzied screams of “Sell, sell, sell or buy, buy, buy!”, The Wall Street Journal and every other publication in between touting with urgency that you must move now or you just missed it, your amygdala is on threat level 4 before you know it. Whatever action you need to take, you better do quickly before you lose more money.
Now breathe. It’s not the end of the world, especially if you have a competent, experienced investment professional at the helm to be the voice of reason. The boiling point is the one at which despite every fiber of your being wanting to jump ship, you stay securely positioned according to your plan. Your advisor’s experience and guidance should be the calm in the storm, serving as the lighthouse to bring you home safely.
If you panic, mistakes can be made. Your brain goes into self-preservation mode and that is where those irrational feelings come from. To tame them, you must be mentally prepared for the inevitable corrections that occur in the stock market.
Next time the stock market declines, turn off the television, stop reading the financial headlines, stop talking to your friends about investing, stop looking at your balance on your telephone or your computer and call your advisor. Out of all the voices you could listen to, listen to the one that matters. You chose your advisor to help you. Market declines are natural, and it’s because of his advice during these stressful times that your advisor truly earns his fee. The best investment professionals are highly trained and skilled at what they do.
Successful investing is the result of two key elements; a competent, experienced advisor who understands the forces of the market and the undercurrents that move it, and a client with express confidence and trust in their advisor who works in concert with their advisor’s recommendations. The combination of expertise, experience and trust will weather most of the financial storms it encounters.