Psychology is not just an important factor in investing—it is really the key determining factor in whether we successfully reach our goals or not. For example, before we can even save any money to invest for our future in the first place, we must overcome to some degree our innate impulse to satisfy immediate wants, and instead relegate funds to the much-less-enticing mental account of later needs. Then once we have committed to a long term savings and investment plan, we face a battery of other heuristic challenges in staying on course.
As a survival technique, our brains are hard-wired to be vigilant for dangers in our environment. We must recognize and understand that in the modern era, this translates into vigilance for perceived dangers to the value of our investments as well as our person. As Nobel-winning behavioral economist Daniel Kahneman said, “The brains of humans contain a mechanism that is designed to give priority to bad news. No comparably rapid mechanism for recognizing good news has been detected.”
Fearful responses to bad news come from the amygdala, a cluster of neurons deep in our limbic brain which is responsible for among other things, the “fight-or-flight” response. The amygdala in more subtle ways can “color” our higher cognitive functions with an emotion at a sub-conscious level, influencing the actions we take. No matter how rational we think we are, this is how our brains are wired and it is folly to assume that we are rational enough, well-educated enough, or simply strong enough to over-ride our biology. So how do we deal with this reality? By implementing “systems” that help keep us on track. There are of course many different strategies one can follow, and existing Hazelbaker clients are familiar with my methods, but no matter what the specifics of the strategy are, it is important to have a strategy, and follow it dogmatically, otherwise one runs the risk of careening from guardrail to guardrail in reaction to market events. In the words of investor James O’Shaughnessy, “If you use even a mediocre strategy consistently, you’ll beat almost all investors who jump in and out of the market, change tactics in midstream, and forever second-guess their decisions.”