Afraid You are a Bad Investor? You are!
What have you done???
That’s right, I said it. You, and you, and you, and you (picture me pointing around a crowded room) are a BAD investor. And it isn’t your fault. As Lady Gaga says, “Baby, you were born this way.”
There is good news and bad news here. Our brains are hardwired to buy investments high and sell them low, just the opposite of how you make money. The culprits are dopamine and the amygdala.
Stick with me.
Dopamine is a neurotransmitter that instructs the brain to make us feel good. Rewards (chocolate, new shoes, investment increases) increase dopamine activity. This can be a good thing, as dopamine regulates our risk/reward behavior. However, when it comes to picking investments, dopamine can be blamed for some risky behavior – and some famous investment bubbles.
Dopamine acts in two ways. If an investor puts 10% of his money in an investment and watches that investment rise dramatically, he feels happy. However, he ALSO feels sad that he didn’t have more of his money in the well-performing investment. The kids these days call this FOMO or Fear of Missing Out.
So, then this investor, to counteract his FOMO and feel more happy dopamine, invests more of his money in the investment that has already gone up. Maybe all his friends are doing the same. This influx of new dopamine-fueled money (see NASDAQ in the late 1990s) creates inflated pricing until the bubble bursts.
Here, in the land of falling stock prices, we meet our friend the amygdala. We like to think of ourselves as rational beings, making decisions with our massively sophisticated, available-to-humans-only pre-frontal cortex. Alas, most of the decisions made by the rational brain are only justifying action on the impulses of our animal brains underneath.
The amygdala regulates our fight-or-flight reflex. It is also the area of the brain that lights up with the most activity when research subjects look at statements where their investments lose money. Our visceral reaction (that is VERY hard to overcome) is to treat falling investments the same as being confronted by a lion. Run away!
There is an answer.
So, if we are born to sell low and buy high, how can we ever use investments to reach our financial and life goals? The answer is simply to invest according to a plan, ignore the news, and rebalance to your target asset mix (not panic-sell) when markets have big swings.
Don’t have a plan? Don’t worry. You can engage with a financial planner to help you, or even turn to some of the new online tools to take the investment decisions out of your hands and use the detached, non-emotional target-date funds for some investments.
All is not lost, and your brain is not the enemy. After all, it told you to read this blog!
By the way, the source for this blog is one of my favorite books, How We Decide by Jonah Lehrer.