I want to talk about the brain’s basic design and how it can lead to some really bad investing decisions. There was an article by ThinkAdvisor written to financial advisors and it was talking about how us equity funds saw huge outflows in the month of April. A lot of this came from a mutual fund that is used by do it yourself investors, so they got hit particularly hard.
This didn’t just happen in the US, it also happened with Canadian mutual funds. Now, what we see here in this chart tells the whole story.
This chart—which is found in my book Confident Investing—shows us that, after market upturns, investors tend to buy stocks and mutual funds. But after the market has a downturn, they tend to sell. Meaning, these investors buy high and sell low.
A neuroscientist by the name of Matthew Lieberman actually explains why this happens. Lieberman says there is an inverse relationship between the amygdala (emotional center of brain) and the prefrontal cortex—where rational thought and judgment sit.
And when the amygdala is active with blood and oxygen, there is less activation in the prefrontal cortex. This causes our thinking power to be disrupted, and causes deficits in our problem-solving. It’s the equivalent of losing 10 to 15 points on your IQ temporarily.
And why is this important?
Well, considering the average IQ of humans is right at about 100. Take 100 minus 15 and you’ve got 85.
And why is 85 important?
Well, a clinical psychologist, named Jordan Peterson has studied the military and their use IQs as a metric to keep our forces the most efficient fighting machine. He says in the American military, you can’t induct anyone into the armed forces if they have an IQ of less than 83, and we’re at 85 remember.
Peterson says, “After hundred of years of research and careful statistic analysis, the armed forces concluded that if you have an IQ of 83 or less, there wasn’t anything that you can possibly be trained to do in the military, at any level of the organization, that wasn’t positively counterproductive.”
Well, think about that as an investor. Literally, we have the same thing going on. This is why investors make such bad decisions, and that is why we use investment policy statements with our investors. What we literally have is a policy statement that says exactly what we’re going to do during market downturns. It helps actually protect us from an amygdala hijack.
By Paul Winkler
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