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Bill Freehling is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Bill Freehling.
Bonehead investments? Blame it on evolution
We buy high during euphoric bubbles, sell low during panicky bear markets.
We chase past performance, selling lagging mutual funds and buying last year’s winners, just before the trends reverse.
We trade too often, driving up broker commissions and leading to hefty tax bills.
We target high-fliers such as Google and Apple while ignoring mundane companies whose profits are high, dividends steady and share prices low.
We overestimate our abilities as investors, thinking we can buck the trend and beat the market.
We hang on every word spoken by the so-called experts on CNBC, despite the fact that there’s little evidence such persons have consistently been right.
We depend too much on the company we work for, filling our 401(k)s with company stock and making ourselves too dependent on its future.
Why are these investing foibles so common? Money magazine columnist and author Jason Zweig gives us a compelling answer in his new book, “Your Money and Your Brain.”
Zweig is the editor of the revised edition of Benjamin Graham’s “The Intelligent Investor,” which is widely considered one of the best books ever written about investing.
As Zweig shows in his new book, human evolution hasn’t made it easy for investors to be intelligent.
“Your Money and Your Brain” delves into the emerging field of neuro-economics, a discipline that combines psychology, neuroscience and economics to study financial decision making.
Zweig makes the case that many of our common investing errors are due to the way the human brain has evolved over time.
When our ancestors were living in caves and foraging for food, it made a lot of sense to be strongly attuned to what risks were out there.
Staying put in the face of a lion attack or drought meant our ancestors weren’t going to live long. So the human brain evolved with a strong sense of fear of risk.
Fast forward several millennia, and investors’ craniums are packed with brains developed to thrive in a more primitive environment. Yet now, instead of rival tribesman invading our living space, bear markets attack our nest eggs.
Upon such a threat, the reflexive parts of our brains immediately tell us to flee and save our assets. The more analytical parts of our brain, the reflective side, can sometimes be overcome by emotions. That leads us to make poor investing decisions.
Zweig shows exactly how the brain works, illustrating how different parts of the mind react when faced with trying financial decisions.
Scoring a financial gain has a similar effect on the brain as taking a hit of cocaine. Our minds are overcome with grief when we lose money, while gains don’t give us a proportionate feeling of pleasure.
Zweig breaks his book down into chapters on greed, prediction, confidence, risk, fear, surprise, regret and happiness. He shows how the mind handles each of these factors.
The book is packed with examples of psychological experiments showing the illogic of so many of the decisions we make about money and more.
So how to overcome the handicaps of the modern mind? As Zweig shows, it’s impossible to prevent your mind from making the snap judgments that evolution has trained it for. Nor is that advisable, as many of the survival mechanisms prevent us from genuine risk.
But readers of “Your Money and Your Brain” will come away with a better understanding of why our brains react the way they do in uncertain times and during both bull and bear markets.
The trick is to understand what’s causing the emotion, and then allow the reflective part of the brain time to think things over. Sometimes the best answer is to simply admit your investing shortcomings and employ strategies involving index funds, dollar-cost averaging, and mutual funds with low expenses and turnover.
This is one of the more unique and valuable books I’ve read on investing. It won’t teach you how to analyze company financials, but it should make you a more intelligent investor.