Decisions, Decisions… Are Yours Good Ones?

Why do smart people make bad financial decisions? More importantly, why do they keep making them? Perhaps they study stocks, market fluctuations, or market indicators. Only a fractional percentage of investors, both professional and amateur, manage to “beat” the market.

Is their occasional above-average-return a fluke?

And what does it show us? According to neuroeconomics, the field dedicated to explaining what is behind human decision making, our brains seek out patterns. When we discover a pattern, or, sense there might be one, the body’s response is to flood the brain with dopamine—as if an opiate (i.e., heroin) is in our system. And the dopamine-flooded mind is neither objective nor dispassionate. Judith Glaser noted in the Harvard Business Review, dopamine causes one to “…feel good, dominant—even invincible.” The irrational appears rational—and one’s investments are affected accordingly. Non-objective thinking can manifest in several ways.

The overconfidence likely to afflict do-it-yourself investors is something they cannot see.

The consequences to the overconfident investor’s portfolio can wreak havoc worse than greed. An investor may know the stock market has seen, according to the Wall Street Journal, an average return of 10 percent over the past century despite market fluctuations and still lose sight of the big picture in the moment. Even when statistics reveal to us we are behaving irrationally, it is in our hardwired biological nature to persevere.

How does overconfidence affect the brain?

Your Money and Your Brain by Jason Zweig provided an unabashed and comprehensive look at the many ways our “intelligent” decisions are shaped. Decisions, when shaped by our biological responses, are not purely objective— and often are not so smart.

Where does this biological phenomenon come into play on Wall Street?

Messengers of financial industry use the principles of neuroeconomics to their advantage. The wildly gesturing doom-and-gloom finance pundits understand this well—as do brokers and financial product salespeople. Our brains quickly react to evocative images of a busy trading floor or the pulsing activity behind the reporter’s head, indicating the market’s ups and downs. And we react. Dan Solin wrote, “Those who study finance regard these activities as counter-productive and calculated to enhance the wealth of the securities industry and deplete the assets of investors… Perhaps investors need the equivalent of drug rehabilitation to reprogram their brains so they can rationally assess the overwhelming data indicating that reliance on the traditional securities industry for investment advice is no different than relying on a drug dealer for advice about kicking a drug habit. . .”

So what can investors do to “beat” neuroeconomic factors?  

The investors who successfully keep as well as grow their wealth have a written plan—and they stick to it.

Don’t forget history — and the fact that it repeats itself.  

Remembering that we’ve lived through this type of volatility, and much worse, before, may ease nervous investors. Don’t forget: Those with a long-term focus who bought into the stock market during the lows of 2008 and 2009 came out ahead over time.

Find the full article here.