As promised in my last column, I want to write about the way the brain processes information and why that makes it so very hard for people to manage their own investments.
It’s not that they cannot do it – it’s just so hard it makes me wonder why they would want to.
I have been fascinated by behavioral finance since my college days, and I have found it to be invaluable in my career as a financial adviser.
The deep dark secret of the investment adviser is that very little of the money we make is earned by finding the right investment for our clients. The bulk of our money is earned by making sure that our clients don’t shoot themselves in the foot along the way.
This is not to say that investors are lacking in skill sets.
I have many clients that are undoubtedly smarter than I, but that doesn’t stop them from wanting to make bad decisions with their investments. The same part of the brain that allowed humans to exist and not be eaten by the dinosaurs is the same part that is getting in the way now.
The brain processes negative information at a much greater level than positive information.
Dr. Martin Paulus from the University of California-San Diego says negative information is processed through the amygdala and medial prefrontal cortex of the brain and is recorded as a threat. It is how we humans remember what not to do (teenagers excluded).
Paulus’ studies have shown if the negative information is strong enough, it can literally keep the brain from doing anything else.
I would think that is how some people when they are overwhelmed by a bad event believe there is nothing to live for and can’t seem to see the good in their lives.
It is certainly why investors wanted to bail on the stock market at the bottom of the crash in 2008 instead of realizing the great opportunity that lay ahead. Even a 10 percent correction in the markets, which happens a lot, can spark an irrational response. If the investor gets out, then he can move on to more appealing thoughts.
Investment decisions are best made from the unemotional side of the brain, and that is virtually impossible when things are not going well.
The fact is that I have much less emotional attachment to your money than I do my own. That makes it easier to make good decisions on your behalf. That is also the reason why you should be very sure that you can trust your adviser and that their interests are aligned with yours.
There are a lot of good people in our business that do the right thing for the sake of doing the right thing, but the only business model that I know of that is structured in the favor of the client is the “fee only” model.
If your adviser is under a different model, make sure you know him or her well.
Scott Reed is CEO of investment advisory firm Hardy Reed in Tupelo. Contact him at (662) 823-4722 or email@example.com