This Is Your Brain. This Is Your Brain On Money.
Let’s face it, the human brain was not wired to manage money. Forage for berries? Check. Keep the hungry lion at bay? Double check. Staying calm and rational during a market meltdown? Not a chance. Bear markets eat most investors for lunch.
Thankfully with a bit of preparation, training (yes, the brain can be trained just as the body), and by putting systems/structures in place, we can turn our worst enemy – our brain – into at least a neutral party, and if not, an ally. Here are some common mental investing pitfalls and techniques to avoid them.
Anchoring: This occurs when we are fixated on the price we paid for a given stock. We hold and hold and hold on to broken companies, waiting for the day when we can get back to our starting point before we sell. The idea of taking a loss is just too painful to bear. The reality is that the stock market has no idea what price you paid and it doesn’t care. The act of investing in securities to have resources for retirement, etc. is not a contest between you and a stock and what you paid for it. So after doing your fundamental research, if you determine a given company is simply no longer a good investment (I am not talking about declines due to overall market drops or temporary headlines like what happened to BA recently), then consider putting that capital into something that has better prospects. Every investor in the world has made mistakes just like every team loses games. The key is to learn from them, let go emotionally (cut the anchor) and move on.
Fearing The Next Big Bad Thing: Since the day stocks bottomed in early March, 2009, individual investors and financial pundits alike have been lamenting (and in many cases predicting – erroneously) the next big crash. Some have actually made a lot of money espousing such doomsday scenarios, only they are not making their money in the stock market (and may even be losing money by shorting stocks). Rather, they are banking on primal fears held by investors that around the next corner lurks that woolly mammoth ready to devour them. The more they scream ugly prophecies, the more people tune in and the more book/ads, etc. are sold. To be sure, one day there will be another bear market (one could argue we experienced one late last year), but as Peter Lynch noted, more money is lost by those preparing for a bear market (by way of opportunity cost) than during the decline itself. Ideally, as encouraged repeatedly here, you have matched your asset class investments with your time horizon (cash for needs in the next 1 – 2 years, stocks for 3-5+ year time horizons, certain bonds and other more stable asset classes for the medium term) and thus have preemptively dealt with the next bear market. But for many, even though they know intellectually that bear markets last on average under 18 months, they simply can’t stand the thought of paper losses and know themselves well enough that they may take action in the heat of the moment (contrary to their long term financial interests). As such, it is perfectly reasonable to set a little more cash aside for the ‘sleep at night’ and ‘stay in the game’ factors. Under this scenario, at least you will largely participate in further stock gains, not panic and sell unnecessarily during a bear market, and better yet, put that cash to work at lower prices.
Risk Aversion: This is the most common investing brain error that investors make on a subconscious level. Simply put, we feel more pain from losses than we get joy from gains, so we do everything possible to avoid that pain. The problem is – and it’s a doozy – we misattribute risk, mistakenly placing it squarely in the ‘volatility’ bucket. As in, if you ask people why stocks are ‘risky’ they will tell you it is because they move up and down a lot (as in they are volatile). However, if you match your assets to your time horizon, then you effectively eliminate what was never a risk in the first place (contact me directly if you want to understand what true forms of risk exist, starting with not knowing what you are doing). Have you ever seen a chart of stocks over 10 or 20 days like we experienced last December? Looks quite scary. How about one that covers 10 or 20 years – the typical holding period for stocks in retirement accounts, etc.? It is pretty smooth. Even though money invested is intended for decades to come, for some reason most investors can’t turn off the TV or look away from their phones. They absorb the daily headlines and machinations and attribute whatever is happening today with risk of stock holdings that have been around for decades and will be here (and making money) long after we are gone. Look at what you own – know what you own. Do you think KO or AAPL or BA are going out of business any time soon just because there is some bad headline or market drop? KO has been paying a dividend since 1893 – do you think some Trump tweet is going to keep the next quarterly payment from hitting your account?
To update a line from Gordon Gekko, Investing is good. Investing is right. Investing works. There are times when turning off your brain and simplifying things – and focusing on what really matters – is the best course of action. You worked hard for your money, you spent thousands and thousands of hours creating that wealth, don’t let your brain undo in an instant of weakness what you have taken a lifetime to build. When times are good, when the waters are calm, spend some time working on your brain just as you (hopefully) do on your body, so that you can use it for, not against, your long-term financial interests.
One of the greatest ways a highly rational and engaged Financial Advisor can help you is to set forth that plan and be there when you are tempted to diverge from it. We all can benefit from external assistance whether it be a doctor, lawyer, therapist, personal trainer or Financial Advisor. We work with those people in part to benefit from their training and knowledge, but also because they have seen every possible worst case scenario and can help you navigate through future ones rather than getting eaten alive in your prime.