Back in 2007, Wall Street Journal investing columnist Jason Zweig contributed a fascinating essay entitled “Fear” to a monograph, Behavioral Finance and Investment Management, published by the Research Foundation of CFA Institute. The essay was adapted from Zweig’s book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, and it’s just as relevant today as it was back then — when, it’s perhaps worth noting, the S&P 500 and other key benchmarks were higher than they are today.
In the essay, Zweig discusses a subject near and dear to my heart as a former investment manager and author: anxiety and its deleterious effects on investment decision making, and hence on performance. Thankfully, human beings are seemingly unique among animals in that we can use our minds to overcome these hard-wired instincts. If only we had a road map for how to do that.
Anxiety is very difficult to control as it operates subliminally. In other words, the brain is hardwired (by its two amygdalae) to immediately respond to stimuli that may turn out to be dangerous. Test after test has demonstrated that when people have a damaged amygdala that they do not respond anxiously to stimuli. This may seem to be desirable, but the amygdalae do help identify stimuli that are legitimately fear-inducing, and therefore actually dangerous. So the goal is not to shut down the amygdalae but to have conscious control of our emotions in the presence of its signals.
So with that in mind here are three key lessons from Zweig’s essay:
Lesson 1: The fear of financial loss always lurks within the normal investing brain.
The amygdalae fire strongly when we make a decision that we know consciously goes against the decision of a group. In other words, standing up for yourself causes anxiety. Researchers have also found that when groups of people sit and watch films together their brains eventually seem to synchronize with one another, and various parts of their brains act in concert with one another. Implicit in this is some sort of notion of a collective consciousness or entrainment of consciousness. That, in turn, helps explain why it is so difficult for investors to go against the grain, even though it is common knowledge that investors exhibit a herd mentality.
Lesson 2: There is an emotional load associated with standing up for one’s beliefs.
Numerous studies have shown that the human mind is built to be anxious about the unknown. In financial markets this reveals itself, for example, in the fact that companies that are more widely followed by analysts have higher trading volumes. A preference for low ambiguity is also shown by the fact that the tighter the earnings estimates are for a given company, the higher (on average) the price of that stock. Again, the amygdalae seem to be in operation in these moments.
Lesson 3: We prefer high predictability.
What can be done to combat these deleterious effects? In short, exercise the powers of your prefrontal cortex or, as it is also known, the reflective brain. Just like any mental aptitude it requires consistent and conscious exercise to become stronger. Here are examples of some steps, in part advocated by Mr. Zweig in “Fear”:
- Get it off your mind. The right time to stop what you are doing is when you feel anxious. Instead, do that which relaxes and rejuvenates you. Go for a run or walk, listen to some of your favorite music, meditate, swim, etc.
- Use your words. Words make use of the prefrontal cortex. Therefore, take a moment to write about the emotions you are experiencing and the facts of a situation to help calm your amygdalae and to activate the reflective part of your brain.
- Track your feelings. Gain consciousness of your emotions, as they are often contra-indicators. Numerous investors have made successful careers out of purchasing investments when the majority were sellers and selling when the majority were buyers. This suggests that periods of abject pessimism are likely good times to consider a purchase. On the other hand, unbridled enthusiasm is likely a good time to consider a sale.
- Get away from the herd. Write down your very specific views about an investment before engaging in a group discussion. This should help you anchor your thoughts against the tidal forces of group think. If you need a second opinion, it helps to seek the opinion of someone you respect that is not a part of a group. Again, this should help you to see your opinion relative to a group’s opinion more clearly. Lastly, it may be helpful to appoint on a rotating basis a person within a group to be a “sniper” whose job it is to shoot down popular opinions.