FIVE WAYS OUR BRAINS make us bad investors

I am obsessed lately with all things neuroscience.  I have been reading up on what prompts us to go to the Survival Brain Loop during conversations v. getting us to the Logical Brain Loop during conversations.   Much of this interest comes from how some of you may know that my son shows up as having ADHD.    People with ADHD (approx. 2-3% of the population) have the tendency to operate in the Survival Brain Loop which is fight, flight, freeze and appease.   Which means they appear as having brain fog as cortisol and adrenaline is pumping out and sending blood to the amygdala (reptilian brain) and thus activates the oldest part of our brains.    Their brain waves also operate in the 25 – 35 MHz. For my son’s football participation this shows up as hyper focus, intense, never vacillating and never rattled. It also shows up as challenges like, multiple step instructions get missed.  Side note:  Did you know that it is suspected that 20% of professional athletes have ADHD and up to 30% of professional football players have ADHD?  It is no wonder.   Put in extraordinarily stressful situations they thrive. 

What puts us in our survival loop?   Telling someone, yelling at someone, or trying to sell someone on a concept.  Basically, it never goes well. 

How do we get to Logical Thinking Brain Loop?   This is the newest part of our brain that has developed over time.   It comes from appreciation, confidence, ownership, validation.   This in turn sends oxytocin and dopamine flowing and sends more blood to the Logical Brain.  Aha!   Which in turn gives us the ability to learn and strategize.   So, back to my football analogy, if you coach my son, how will you get him to do what you want him to?  Tell him?  NO WAY.  He is already in fight or flight likely.   So, to get him to the logical brain you need to give him confidence and appreciation and ownership as to what task you want him to do.   For those who care, when you are in your logical brain, your MHz typically drop.  Ideally when you are very calm and calculated you would be in the 12-16 MHz.

Why am I reviewing this?  Well, because much of our brain is NOT BUILT to make us good investors.  There has been a study around for at least 30 years that shows what a mutual fund earned annually v. what the avg investor in that mutual fund earned.  Shouldn’t they be the same?   Well, they aren’t.  Because the investor made poor behavioural decisions on buying at the wrong time and selling at the wrong time.

https://www.franklintempleton.ca/en-ca/planning/investor-education/behaviour/availability-bias

 

Here are five (there are many more!) common behavioural biases that can lead to bad investment decisions.  And by the way, this can be applied to any decision like purchasing real estate and making a business acquisition. 

1. Loss Aversion

You may know that stomach-churning feeling that comes with losing money on a stock? That pain sometimes seems to hurt more than the joy of seeing your portfolio rise. There is a term for this feeling: loss aversion, and it can cause you to make irrational decisions, such as panic-selling investments that can throw off your financial plans.

Consider what happened in March 2020, when investors sold their stocks en masse, fearing the economic fallout from the initial pandemic lockdowns. The markets bounced back within weeks and, within months, reached new highs, rewarding those who stayed calm and held on.

Loss aversion can also drive you to sell your winning stocks for quick returns even when there are signs the market can climb higher, and hold on to your losers, hoping they’ll move higher again. It can also prevent you from taking any risks, which can stunt your portfolio performance over the long term.

2. Herd Mentality

There’s nothing like news of a hot stock or sector to rally investors into buying more. It’s called herd mentality and it happens if you decide to follow the crowd or market buzz around an investment without asking questions or doing your own research.

Examples include the “meme stock” frenzy during the early days of the pandemic and the cryptocurrency craze in more recent years. While joining the herd can lead to huge gains in the short term, many investors ultimately lose out when they jump on bandwagon investment decisions.

That’s why it’s important to do your own research and consult with your financial professional before selecting which stocks to buy and determine how much, if any, of those investments are suitable for your portfolio. The right answer will always depend on your risk tolerance and short- and longer-term investment goals.

3. Confirmation Bias

Have you ever felt unsure about a purchase or personal matter and sought validation from someone you know who shares your perspective? We all do. It’s called confirmation bias. It’s when we actively seek out, interpret, and retain information that aligns with our beliefs. It makes us feel better.

Seeking approval from like-minded people can help you make decisions, but it can also create blind spots. When you only focus on what you know or believe, you risk missing contradictory information that could negatively (or positively) impact your portfolio.

Confirmation bias has also been known to cause some investors to become obsessed with a few companies or investment types. When this happens, your portfolio could become less diversified, which could mean you’re exposing yourself to too much risk – or too little – depending on your investment needs and goals.

4. Overconfidence

When you’re starting a company or growing your wealth, you need to have a lot of confidence in your decisions – but overconfidence can be costly. If you’ve ever driven to a new destination without consulting a map, only to end up lost, chances are you’ve experienced overconfidence bias. Some investors can have the same self-assurance when wading into a stock or a sector, leading them to take unnecessary or even excessive risks.

While successful investing may require some hubris, it’s usually the result of doing your due diligence, and consulting with your financial professional to examine a stock’s fundamentals, the sector’s health and any broader macro-economic trends that may impact its performance.

5. Anchoring

Many of us prefer the path of least resistance, so when we hear or read something that sounds convincing, we’ll rely on that single bit of information to make a decision. It’s like agreeing to go to a movie because you like a certain actor, without knowing anything about the plot.

The same thing happens when you’re investing, although the consequences can be much bigger than potentially watching a bad flick. For investors, this trait is known as “anchoring bias.” For instance, you might invest in a stock based on your first impression of their product, without taking the time to see how well the company’s managed.

For us as Wealth Counselors to the quietly wealthy we know that rigorous long-term planning, goal-focused investment policy and insusceptibility to extreme emotional reactions can’t be practised, much less mastered, by the individual investor acting alone.   Declining investment values inflect twice as much psychic pain as increasing values generate positive emotions.  Second, human nature cannot distinguish between temporary declines and permanent losses.   That is, it can’t tell the difference between genuine risk and mere volatility.   Moreover, human nature is, with respect to investments, pro cyclical.  In every other area of economic life, humans become increasingly eager to buy things the more their prices are marked down; they shy away from buying items whose prices are unusually high and rising.    Concerning investments in general, and equities in particular, these impulses suddenly reverse.  Human nature thinks that when an investment’s prices is rising strongly, its risk in declining and profit potential increasing.  Whereas when prices are tumbling, people think the return potential is declining and the risk rising.

These very human instincts must produce disastrous investment outcomes – unless us as Behavioural Investment counsellors intervene.   By the way, did you know the actual cost of that has been identified as up to 3% annually!  Imagine.  If you are paying less than 3% for wealth advisory services, that in itself produces a gain.