Investor Psychology — ignore your brain
The ‘don’t blame me’ blurb: I am not a financial advisor, portfolio manager, or accountant. This is not tax or investment advice; it’s information to get you going. Please consult your trusty professional and do your due diligence. Carry-on!
It’s March of 2020, Covid is killing people by the tens of thousands nationwide. D.C., where I live, has just been put under a stay-at-home order. There is no one on the streets, it’s like a scene from a Michael Bay movie just before the aliens attack.
I’m a Director of Photography (a fancy cameraman), and my day job is filming documentaries and news magazine programs for shows, including 60 Minutes. CBS had just emailed me a letter from the Department of Homeland Security for camera crews to carry as we deemed ‘essential communicators’ during Covid. It stated that law enforcement, ‘must let the bearer pass and be given access to vehicle fuel’. I turn to sound guy Mark Wilson, “How bad is this going to get Wilson?” We have both filmed conflicts around the world, including in Iraq and Afghanistan, but this letter was a worry.
At the same time, the stock market was crashing. It had dropped around 30%, reacting to the economy being switched off like a light bulb, for who knows how long.
I felt like I would puke; my portfolio had dropped $200,000. My brain screamed, “Sell, sell everything! Get out!”. So, instead, I logged in to my Schwab account and started buying. I had just sold a rental house that I co-owned with a mate and had some cash on hand. Every Monday, I brought a total of $16,000 divided into four or five ETFs for the next eight weeks. I ignored my brain’s primitive response to a crisis and followed investing principles:
Stay calm.
Never sell in a crash.
Stay in the market long term.
Keep buying.
I used the ‘every Monday plan’ to control my emotions. Some Mondays, it seemed insane to buy, but I kept going.
The world didn’t end, but it sure felt like it was about to. You got hosed if you sold in 2020 during the crash and waited until 2021 or later to buy back in. If you kept buying throughout the crash you got sale prices.
Famous investor Warren Buffett once said:
“Be greedy when others are fearful, and fearful when others are greedy.”
Peter Lynch, legend Fidelity fund manager:
“The key to making money in stocks is not to get scared out of them.”
The classic mistake investors make over and over again is to sell out of fear or panic during or after a crash, then wait on the sidelines for months or years for things to get rosy again. Only then do they buy back in again once the market has recovered, missing all the gains on the way up. That’s called selling low and buying high.
What should you do? Stay invested in a crash, buy more as the market crashes, and keep buying as it slowly recovers; you are buying stocks at sale prices.
The emotional response
The thing that trips investors up is their emotional response. The market isn’t the problem; our brains, which evolved on the savannah, are. It turns out our amygdala, the primitive part of the brain that reacts to threats like a tiger running at you, lights up when the market drops. But it’s your portfolio that is about to be murdered (temporarily!), not you. Your brain wants you to run, which means selling.
Let’s talk about ‘our issues’. No, not the ones your spouse complains about, different ones:
1. Impulsive Decision-making: Emotions, like fear and greed, can lead to impulsive decision-making. For example, fear might drive you to sell assets hastily during a market downturn, potentially realizing losses. Don’t give in to the dark side!
2. Market Timing Issues: Emotional reactions often lead to poor market timing, this is us losing it. If you panicked and sold in March 2020 during Covid you would have lost a fortune. Trying to time the market is nearly impossible; emotional decisions can result in missing out on potential gains or incurring unnecessary losses.
3. Overreacting to News: Emotional investors tend to overreact to positive or negative news. This overreaction can lead to buying or selling assets based on short-term news rather than long-term thinking. Think in decades, not weeks or months.
4. Herd Mentality: Emotions can contribute to a herd mentality, where investors follow the crowd without conducting their own due diligence. This behavior can result in market bubbles and crashes, as everyone rushes to buy or sell based on the actions of others rather than on rational analysis.
5. Confirmation Bias: This is like living in your own echo chamber. You only pay attention to information that agrees with your decisions and ignore anything that doesn't. It's like if you buy a stock and only read good news about it, ignoring warning signs.
6. Short-Term Focus: We have evolved to be concerned with the now or tomorrow; can we survive in the short term? Our brains are not wired to think about the you in 30 years, which is what investing is really all about.
What am I getting at? Hold Fast. Stick to the plan.
It’s ok to have emotions, be uncomfortable, and be a little scared. We all are when the shit hits the fan. But stick to the plan, buying our ETFs or Funds every quarter in the Three-Fund Portfolio and ignore all the noise. Think long, long term. Those media reports on current events may be scary, it’s their job to report on the now. What they don’t do is report on a market crash and say, “But over the long term, the market will be fine, keep investing”. As an investor, it’s your job to remember that when your brain is acting up.
If you have not already have a look at the Three-Fund Portfolio, use it inside an i401k or in a taxable individual account.