Neurology of Investing – Part II

This article was originally published for RC Peck’s Fearless Wealth Newsletter in February 2008.

Getting the Critter Brain Out Of the Picture

We left Part 1 of this article after talking about the differences between the critter brain and the human brain, and how beliefs coded in the critter brain can raise havoc with your investing behavior.

It’s interesting to note that influencing belief systems may not be specifically about money. Other beliefs can get generalized and affect your attitude about money.

For example, your critter brain might be coded to stay with the crowd (just like it did 10,000 years ago on the African plains). This belief is very powerful (the part of the brain that lights up in response to pain is the same part of the brain that, in this case, lights up when going against the crowd). Interesting, isn’t it? Are you starting to understand how the critter brain might be working against you when it comes to growing your money?

Trying to stay safe is a big contributor to why investors inadvertently buy at the top and sell at the bottom. Buy what is hot, buy what is exciting, and in the process of staying safe investors are likely to under-perform the S&P 500.

An unmanaged S&P 500 index fund beats 87% of the world’s money managers because the critter brain is wired to run with the crowd, even if the crowd is losing money. This could be a problem if you want results different from what the crowd is getting.

Both the critter brain and the human brain are good at what they do because they learn very well. The critter brain learns quickly, early in life, and then locks in that learning to keep you safe for all eternity.

The flip side is that it’s very difficult for the critter brain to unlearn. Most of what the critter brain has learned about growing money doesn’t work, yet it continues to serve as the basic driver of our instincts.

If you want a different experience you will have to recode your critter brain.

The Solution

We have two choices: 1) Unlearn what we and our ancestors have learned over eons (this could take many years), or 2) Create a situation that prevents the critter brain from sabotaging or playing a part in stock market decisions (this takes days).

You’ll want to create a situation in which the critter is not paying attention, right? The way to keep the critter brain from participating in stock market decisions is to eliminate the “triggers” or “patterns” that the critter brain recognizes as not survivable.

In the investing world these patterns are called “investing biases.” When we are stuck in an investing bias we are prevented from objective planning; we become subjective and start guessing. This puts our critter brain in a situation where it needs to ask the question “Can I survive this?”

There are many investing biases, and some of the most common are stress biases, future forward bias, reaction bias, relationship bias, familiarity bias, story bias, self-attribution bias, over-confidence bias, false-anchoring bias, news bias and illusion of control bias. If you are human and have been born on planet earth, regardless of how you earn a living, then you have these biases already hardwired in your critter brain.

If these biases are taken out of the investment conversation, we can eliminate the critter brain’s influence; it doesn’t even think of asking the question “Can I survive this?” and then your human brain can go to work.

Eliminating investing bias involves four connected steps. The steps are simple, but they must be done congruently to prevent the critter brain from being triggered. Let me share one of them with you: If you want to bypass the critter brain you must limit contact with the stock market or your individual positions to no more than once a month, and I’ll tell you why. Losing money is coded as pain in the critter brain.

If you check your investment Monday morning and it is down $100, even if you are up $5,000 in the stock, this loss will be coded as pain and will carry a negative weight. This weight is four times heavier than a win or winning situation, and the weight will tell your critter brain that you are in danger.

Again, when the critter brain thinks it’s in danger it goes into fight or flight mode, which leads to actions that will not work for the benefit of your stock market portfolio. Under control of the critter brain, the human will do one of two things with its investments: 1) Sell its winners way too fast, or 2) Keep its losers way too long.

If you choose to look at the market every day, hour, or week, then in order for your critter brain to have a positive experience you will have to be winning five times more often than you are losing. The probability of this is so low that it almost never happens. The best investors in the world only win 40% to 50% of the time, not 80% to 90%. And so the solution is to limit your contact with the stock market. Simple, but not easy!

The three other steps, in combination with this one, will help you manage your downside risk while allowing your winners to keep growing. These four steps will keep your critter brain out of the loop and will allow your human brain to make the choices you want made.

If you make the changes I recommend, you will soon be looking back and noticing how much better your money is growing. Some of you may be satisfied with the results you are getting from the stock market. If you are, then keep doing what you’re doing. For those of you who would like different results, you will be amazed at how you can achieve them with just one or two small shifts in your investing behavior.

The best is yet to come,
RC’s Signature