Marah Curtin Director of Client Engagement
11th May, 2020
When we feel our personal security and safety is at risk, like we do in times of crisis, we tend to react in one of three ways—fight, flight or freeze. However, what might have been good survival mechanisms in the caveman days, can be pretty poor strategies when it comes to someone who has just lost their job or has come under significant stress.
The brain is incredibly complex. For our purposes, we’re going to break it down into three parts—these “brains” sometimes work cooperatively, sometimes antagonistically. The Reptilian complex controls things required for survival, such as breathing, heartbeat, and body temperature. The Limbic system is our instinct center—it’s where our social and nurturing behaviors and emotions such as love, hate, fear, surprise, anger, and hurt reside. It’s also where our fight-or-flight reflex is controlled. And finally, we have the Neocortex, which is where higher human thought takes please―it’s our language and reasoning center, and where our mathematical ability lies.
The physiology of our brains tends to work against our interests as investors. When we make decisions, we think we’re being logical and rational—and when we’re being logical and rational, we’re activating the Neocortex. However, when humans are in a state of great emotion, such as fear, surprise, or rage, the blood drains from the Neocortex and flows to the Limbic system and Reptilian complex—literally making us dumber. It can take hours to regain our reasoning ability in that part of the brain.
Don’t get me wrong, emotions can be useful in directing our attention and energy toward what we feel are the most important aspects of a decision. That said, intense emotions may lead us to make misguided decisions, not to mention outright disastrous ones. Pretending we’re not susceptible to our emotions when making big financial decisions only increases the likelihood that we’ll make mistakes.
As human beings, we have this remarkable ability to sabotage investment plans—two of the most common and costly being to buy high and sell low. Successful investing involves rational, logical thought and actions. Yet many people are afraid to make decisions, rely too much on hot tips or simply procrastinate.
Volatile markets will test the mettle of even the most experienced investors. Many wind up selling stocks when prices are at their lowest in favour of the safest, often lowest earning, assets—a strategy that can greatly lengthen the time it takes an account to recover.
Investing behavioural biases can be either cognitive or emotional. While cognitive biases stem from statistical, information processing, or memory errors, an emotional bias stems from impulse or intuition and results in action based on feelings instead of facts.
You can minimize the damaging effects that these tendencies have on long-term goals by watching out for these biases and following a few simple principles.
Loss aversion is the tendency to strongly prefer avoiding losses to acquiring gains. Some studies suggest that losses are twice as powerful psychologically than gains.
Recognise “I can’t take any more of these losses, so I’m selling now.”
Overcome Expect ups and downs in the market. Involve impartial people in your decisions, since they’re less likely to be clouded by emotion.
Anchoring is the tendency to rely too heavily on one trait or piece of information when making decisions.
Recognise “Six months ago, I had €XXXX, and now I have HALF that amount.”
Overcome Seek out information that will give you long-term perspective and help you change your anchor. Measure your success based on progress toward your goals.
Status quo is the tendency to not change an established behavior unless the incentive to change is compelling.
Recognise “I’ve had that investment for years and it’s been a good one. No need to change it now.”
Overcome Make a financial and investment plan and stick to it, but revisit the plan periodically to ensure that it still aligns with your long-term goals.
Herd mentality is the tendency to adopt the beliefs and behaviours as those around them. It’s perhaps the most well-known of biases, yet the most common—especially in the midst of uncertainty.
Recognise “I should sell my investments as everybody is doing it and everybody can’t be wrong.”
Overcome Conduct your own research and get professional advice. Base your decisions on facts and your personal financial goals, not on other people’s decisions.
Talking about money is the ultimate taboo. We grew up being told that it was impolite to talk about money, so we’re typically not very good at it. My advice is to just start—grab someone you want to talk about money with and just start talking. Maybe start with your parents if you’re lucky enough to still have them around. Ask them what they wish they had done differently at your age or ask who they go to for advice.
And for those of us who are married, many understand all too well why money is consistently ranked among the top reasons why couples fight (second only to sex and followed closely by kids, if you have them)! So as important as it is to talk about money with you partners, I suggest you set a few ground rules:
Bottom line: we need to get comfortable talking about money. If we never talk about money, then when we need to talk about it and the pressure is on or emotions are high, it’s going to be much more difficult. You may find yourself in this exact situation right now.
If you need any information, advice or reassurance during these challenging times, why not request a call today.
Warning: The information in this article does not purport to be financial advice and does not take into account the investment objectives, knowledge and experience or financial situation of any particular person. You should seek advice in the context of your own personal circumstances prior to making any financial or investment decision from your own adviser.
