I have said this before: I am fascinated by how people make decisions. Decisions have a great impact on every part of your life, which includes your investment goals. I always am looking for real-life experiences people can relate to that will help them understand how to better invest their assets.
First, let me spend a bit of time on the decision-making process. Different decisions are made in different parts of your brain. It’s really extraordinary to think about.
Decisions are basically divided into two categories. The first are decisions that require thought and reason. They are decisions that need to be thought through and they require cognitive skills in order to make good decisions. The second are decisions that need to be made quickly and decisively. They often are called “flight or fight” decisions.
They go way back to the time when cavemen were cooking some kind of meat for themselves only to find that they were really just short-order cooks for the local sabered-tooth tiger.
Do you eat your food or run and possibly starve? Even though you know you need the food, you also know that full stomachs are no good on a dead man.
Even though there are plenty of reasons to use the “fight or flight” part of your brain, it is not as useful as it once was. But that just hasn’t stopped us from using it over and over again in the wrong situations.
During the depth of the last recession, I talked to countless investors who wanted to get out of the market when in actuality it was priced more to their advantage than it had been in years.
The flight mode was in full swing even though the fundamentals of the markets just didn’t add up to a sell. I’m not saying that the markets couldn’t have been forced lower by investment behavior, but there certainly was a closeout sale on the stock market then.
Managing the issue
It was not hard to notice what part of their brain was being used. It’s not what side of the trade you take and it isn’t how smart you are that gives you away. It comes down to how you manage the issue.
If you can’t offer well thought out solutions, you probably are thinking with the wrong side of your brain.
It’s like that comedian who used to talk about making people wear a sign when they do dumb things. You could do the same with people who use the emotional part of their brain to make investment decisions.
If you are already counting your profits before you buy a stock, here’s your sign. If you bought a lake house and are going to pay for it when you sell your stock, here’s your sign.
If you can’t get back in the market because you think it might go to zero, here’s your sign. If you think you are diversified because you own three different oil companies, here’s your sign.
In my view, the difference between the thoughtful/reasoning process and the “fight or flight” process is one of the biggest challenges to investing well.
If you just “feel” like something is a good investment, that’s just not good enough.
If you get caught up in how much money you might make from an investment, it is time to start worrying about your decision.
The moment you get excited is the moment your mind starts functioning in “fight or flight” mode.
It might not be a bad idea to put on a heart-rate monitor when you make your decisions.
Don’t make investment decisions when your heart rate is over 110. Investing is a business and the decisions affect your life in a big way. Your decisions should be made by the right part of your brain.
Learn to recognize how you are making your decisions and stop when you are doing it wrong. That can be said for investing and any other decision that can have a significant impact on your life.
Scott Reed, CIMA, AIFA, is CEO of Hardy Reed LLC in Tupelo