Is Your Brain Wired For Wealth?
It never ceases to amaze me how with all the various sources spewing forth investment information, few, if any of them ever devote any time toward talking about the most important "tool" that each of us has available to us as investors... I am referring to our minds.
Stunning investment insights are coming from one of the least likely fields you could imagine: neuroscience. Here is where researchers are using the latest breakthroughs in technology to trace the exact circuitry your brain uses to make the kinds of decisions you rely on as an investor.
Now, for the first time, we will take you deep inside your own brain to help you understand why you invest the way you do -- and, more importantly, how to enhance the workings of your brain to get better results.
The neuroscience of investing helps explain one puzzle after another: why we chronically buy high and sell low; why "predictable" growth stocks sell at such high prices; why it's so hard to understand our own risk tolerance until we lose money; why we keep buying IPOs and "hot funds" despite all of the evidence that we shouldn't; and why penny stocks that miss earnings forecasts by a penny can lose billions of dollars of market value in seconds .
Fortunately, the latest discoveries also point the way toward cures for bad investing behavior. Investors are human, therefore knowing how the human brain works and why we react the way we do to various situations are critical for developing a better understanding of the common mistakes that typical investors make.
For nearly our entire history as a species, humans were hunter-gatherers, living in small nomadic bands, pursuing wild animals, foraging for edible plants, finding mates, avoiding predators, and seeking shelter in bad weather. Those are the tasks our brains evolved to perform.
The human brain is a superb machine when it comes to solving ancient problems like recognizing short-term trends or generating emotional responses with lightning speed. But it's not so good at discerning long-term patterns or focusing on many factors at once -- challenges that our early ancestors rarely faced, but that we investors confront every day.
Now, the question this raises is how can you use these new insights into the brain to make yourself a better investor?
Whenever possible, you need to develop automated, irreversible investing habits that are tailor-made for neutralizing your brain's worst liabilities, while optimizing its greatest assets. Now here's how neuroscience leads to a new science of investing.
There is a part of your brain that initiates feelings of fear and it is known as the amygdala. These feelings can act as an almost irresistible force and therefore you must reduce your exposure to any images that can induce such feelings of fear, and cause your commitment to investing to weaken.
The human brain is wired to try to make predictions from past patterns and take risks in the search for a big reward. That makes sense only if you're following the footprints of a tasty water buffalo or looking for flowers that indicate an edible root plant. With stocks, that habit can lead you quickly astray as you invest in a few stocks based on past performance. Geniuses like Warren Buffett can get away with putting all their money in a handful of holdings, but the rest of us need to set limits on our prediction addiction.
Redouble your research if a stock or fund goes straight up, don't just enjoy the ride. The better an investment does for you, the more powerfully your brain will believe nothing can ever go wrong with it. Each time it rises, say, 50 percent, study it again more closely; ask what could go wrong; seek out negative opinions. The time to do the most homework is before bad news can catch your brain by surprise. There are no guarantees, but doing extra research just when things are going well is the best way to prepare yourself in case something later goes wrong, or seems to. You'll then have a better sense of whether it's a false alarm or a real one.
Build an emotional registry. Remembering what you did is only one way to learn from your own experience. Emotions can be an excellent guide to what you should and shouldn't do. But to use them as an accurate guide, you need to remind yourself of how you felt after your decisions (and their results). Regularly evaluating whether an outcome made you feel good or bad will help you learn from your behavior. Keeping a written record of your feelings is a good idea, particularly if you are a younger investor.
Look at the long run. Remember that your brain perceives anything that repeats a couple of times as a trend -- so never buy a stock or a fund because its short-term returns look hot. Check out the long-run, and never assess performance in isolation; always compare a stock or fund to other similar choices.
Because your prefrontal cortex is responsible for evaluating the consequences of your actions, and because advancing age impairs that part of your brain, always be on guard. Never open unsolicited investing e-mail.
And now let's talk about the biggest risk of all to you as an investor: underestimating your own tolerance for risk. Thinking you can tough it out, then suddenly finding you can't, is a recipe for financial disaster. Diversification --making sure that you never keep all your money in one kind of investment -- is the single most powerful way to prevent your brain from working against you. By always holding some cash, some bonds, some real estate, some U.S. and foreign stocks, you ensure that your prediction addiction can never force you into a single, sweeping bet on a "trend" that disappears. And by keeping your money in a broad basket of assets, you lower the odds that a meltdown in one investment will send your amygdala into overdrive.
Putting yourself on investing autopilot minimizes the opportunities for your brain to perceive trends that aren't there, to overreact when apparent trends turn out to be illusions or to panic when fear is in the air. That frees up your brain to focus on the harder work of long-term financial planning. Above all, you should take enormous comfort from knowing that the latest scientific findings show just how newly valid the oldest truths of investing really are.
* * * * *
Stunning investment insights are coming from one of the least likely fields you could imagine: neuroscience. Here is where researchers are using the latest breakthroughs in technology to trace the exact circuitry your brain uses to make the kinds of decisions you rely on as an investor.
Now, for the first time, we will take you deep inside your own brain to help you understand why you invest the way you do -- and, more importantly, how to enhance the workings of your brain to get better results.
The neuroscience of investing helps explain one puzzle after another: why we chronically buy high and sell low; why "predictable" growth stocks sell at such high prices; why it's so hard to understand our own risk tolerance until we lose money; why we keep buying IPOs and "hot funds" despite all of the evidence that we shouldn't; and why penny stocks that miss earnings forecasts by a penny can lose billions of dollars of market value in seconds .
Fortunately, the latest discoveries also point the way toward cures for bad investing behavior. Investors are human, therefore knowing how the human brain works and why we react the way we do to various situations are critical for developing a better understanding of the common mistakes that typical investors make.
For nearly our entire history as a species, humans were hunter-gatherers, living in small nomadic bands, pursuing wild animals, foraging for edible plants, finding mates, avoiding predators, and seeking shelter in bad weather. Those are the tasks our brains evolved to perform.
The human brain is a superb machine when it comes to solving ancient problems like recognizing short-term trends or generating emotional responses with lightning speed. But it's not so good at discerning long-term patterns or focusing on many factors at once -- challenges that our early ancestors rarely faced, but that we investors confront every day.
Now, the question this raises is how can you use these new insights into the brain to make yourself a better investor?
Whenever possible, you need to develop automated, irreversible investing habits that are tailor-made for neutralizing your brain's worst liabilities, while optimizing its greatest assets. Now here's how neuroscience leads to a new science of investing.
There is a part of your brain that initiates feelings of fear and it is known as the amygdala. These feelings can act as an almost irresistible force and therefore you must reduce your exposure to any images that can induce such feelings of fear, and cause your commitment to investing to weaken.
The human brain is wired to try to make predictions from past patterns and take risks in the search for a big reward. That makes sense only if you're following the footprints of a tasty water buffalo or looking for flowers that indicate an edible root plant. With stocks, that habit can lead you quickly astray as you invest in a few stocks based on past performance. Geniuses like Warren Buffett can get away with putting all their money in a handful of holdings, but the rest of us need to set limits on our prediction addiction.
Redouble your research if a stock or fund goes straight up, don't just enjoy the ride. The better an investment does for you, the more powerfully your brain will believe nothing can ever go wrong with it. Each time it rises, say, 50 percent, study it again more closely; ask what could go wrong; seek out negative opinions. The time to do the most homework is before bad news can catch your brain by surprise. There are no guarantees, but doing extra research just when things are going well is the best way to prepare yourself in case something later goes wrong, or seems to. You'll then have a better sense of whether it's a false alarm or a real one.
Build an emotional registry. Remembering what you did is only one way to learn from your own experience. Emotions can be an excellent guide to what you should and shouldn't do. But to use them as an accurate guide, you need to remind yourself of how you felt after your decisions (and their results). Regularly evaluating whether an outcome made you feel good or bad will help you learn from your behavior. Keeping a written record of your feelings is a good idea, particularly if you are a younger investor.
Look at the long run. Remember that your brain perceives anything that repeats a couple of times as a trend -- so never buy a stock or a fund because its short-term returns look hot. Check out the long-run, and never assess performance in isolation; always compare a stock or fund to other similar choices.
Because your prefrontal cortex is responsible for evaluating the consequences of your actions, and because advancing age impairs that part of your brain, always be on guard. Never open unsolicited investing e-mail.
And now let's talk about the biggest risk of all to you as an investor: underestimating your own tolerance for risk. Thinking you can tough it out, then suddenly finding you can't, is a recipe for financial disaster. Diversification --making sure that you never keep all your money in one kind of investment -- is the single most powerful way to prevent your brain from working against you. By always holding some cash, some bonds, some real estate, some U.S. and foreign stocks, you ensure that your prediction addiction can never force you into a single, sweeping bet on a "trend" that disappears. And by keeping your money in a broad basket of assets, you lower the odds that a meltdown in one investment will send your amygdala into overdrive.
Putting yourself on investing autopilot minimizes the opportunities for your brain to perceive trends that aren't there, to overreact when apparent trends turn out to be illusions or to panic when fear is in the air. That frees up your brain to focus on the harder work of long-term financial planning. Above all, you should take enormous comfort from knowing that the latest scientific findings show just how newly valid the oldest truths of investing really are.
* * * * *
posted by Bob Moser at
5:21 PM
0 Comments:
Post a Comment
<< Home