It’s why you’re happy to scour the Internet for Bachelorette spoilers weeks before the finale…
It’s why you’re willing to watch talking heads jabber away for months before the Big Game even starts…
And it’s also why you recently lost a lot of money in the stock market.
It’s called prediction addiction, and it’s a pretty normal function of the human brain.
Though it can be fun and harmless in some situations, it can be devastating in others—especially emotional investing.
The Real McCoy: How Investors’ Brains Actually Work
Standard economic theory, taught in every reputable business school and economics department for more than 50 years, holds that human beings are capable of always making rational decisions and that markets and institutions, in the aggregate, are healthily self-regulating.
James Montier, author of The Little Book of Behavioral Investing, describes these two decision-making systems using Star Trek characters Dr. McCoy and Mr. Spock. Dr. McCoy, a human, allowed his emotions to rule him. Mr. Spock, half human and half Vulcan (a species that suppressed all emotions), prided himself on allowing only logic to drive his decisions.
When teaching finance and making public policy, the intellectual morons in academic finance have assumed you and me are like Mr. Spock when it comes to making decisions—unemotional, detached, and logical.
BUT in 2008, Alan Greenspan, the former Chairman of the U.S. Federal Reserve once hailed as “the greatest banker who ever lived,” confessed to Congress that he was “shocked” that the human beings in the markets did not operate according to these principles. Humans hardly ever acted the way the models predicted.
A mix of psychology, economics, and evolutionary biology shows that we humans make investment decisions the way Dr. McCoy would—emotional, involved, and often illogical. Humans are predisposed—it’s built into the autopilot part of our brains—to make investment decisions using the emotions along a continuum between fear and greed.
In light of research showing that the average investor has underperformed the markets during the last two decades, we have developed processes and rules that help clients earn sufficient returns while avoiding the emotional pitfalls wired into our brains.
How Do You Say “Sell” in Vulcan?
No, Mr. Spock wasn’t 100% human, and that may have given him an advantage with rational thinking. But that doesn’t mean that you shouldn’t strive to be more level-headed, especially when it comes to investing in the stock market.
Consider some of the potential consequences of emotional investing:
- getting trapped in a “buy high, sell low” situation
- missing out on a great new stock because the story is not so “exciting”
- taking permanent losses that prevent you from earning exploding returns from the power of compound interest.
Start Investing Smarter Today
It starts with knowing the true indicators of value, as per EVA™. And it means establishing a plan and sticking to it—even in the throes of a recession, stock market correction, or bear markets. Remember: corrections and bear markets are simply temporary interruptions of a permanent uptrend—take advantage of it, don’t fight it.
Sign up for my email list and get more thoughts on emotional investing delivered straight to your inbox. And learn even more about this in person at my second live event on October 8, 2015: Save Your Retirement 2.0: Why Investing is Simple but Not Easy. Vulcan lineage not required! Stay tuned for more details soon.