Investors need not waste time worrying about what they can’t control, like market volatility and its many causes, because there is a greater threat to their financial success and it comes from within.

The internal battle we face is a war between our primitive minds and our current reality, where some of these primal survival skills are outdated, if not useless. The cognitive biases that kept the species alive, can lead to making less than optimal financial decisions – especially if we are unaware of them.

According to James Clear (Atomic Habits), much of our behavior is rooted in reducing uncertainty, relieving anxiety, and winning social acceptance/approval. At the heart of these inclinations is the goal of propagation of the species. Our cognitive biases encourage us to be part of a tribe to stay safe (and alive) in order to multiply.  But for a modern-day investor, the greatest success comes from taking risk, and going against the crowd’s greed or fear. Understanding these cognitive biases is crucial to overriding them and not mistaking them as “gut instincts.”

The Last Experience Might Not Be Replicated

Our ability to not repeat mistakes is the Recency Effect at work, which is how we learn not to touch a hot stove. We associate the last experience in a given situation as one that will be replicated. But, not all situations have as certain an outcome as this. When it comes to investing, this bias leaves investors believing that the next experience they have will be the same as their last (for better, or for worse). This can lead investors to be overly fearful, sitting in cash at the worst time; or, investing aggressively, thinking the next new high is on the horizon. However,  just because it happened last time isn’t a strategy. 

Fear is Instinct, Not Intuition

Survival instincts have us place more emphasis on negative thoughts and perceived threats. This Attentional Cognitive Bias even shapes the way we remember experiences. We are more likely to remember the magnitude of the pain of loss than the highs from the joy of a win. When combined with the Recency Effect, it is a potent cocktail that keeps once-bitten shy investors perpetually sitting on the sidelines, waiting to re-enter, and never able to jump back in. The result is missed opportunity and wasted years that could have been spent compounding investment results to build wealth overtime.

Surrounded by Information and Agreement Clouds Judgment

A cognitive bias made particularly potent in our modern era is Availability Heuristic, which places greater importance on information that is readily available (e.g., virally spread) regardless of its merit. In addition, algorithms serve up a daily diet of content that echoes what we already believe. And this Confirmation Bias creates confidence that we are right because there is a whole tribe of people in agreement. This is how irrational exuberance takes hold, leading investors to gorge en masse on stocks that cost more than they are actually worth.

Dial Back on Emotion

The only way to handle our modern day investment challenges is to dial back on the very thing that helped keep us alive – our emotional response to stimuli. Fortunately, there is data going back to the 1920s that shows how different types of investments have performed over various time frames (with stocks being the strongest performer). We can look to volatile times in the market’s history and see now that these were buying opportunities for long-term investors. While past performance is no guarantee of future results, probability is all an investor can look to.

Still, on an emotional level it can be difficult to make the decision to invest. This is where automation and technology can be used to establish a systematic investment plan to buy every month, regardless of market performance. Automation frees investors from the angst of decision making, or trying to time their investments. It offers a reprieve against the onslaught of  information (and misinformation) that triggers our cognitive biases.

Most importantly, it makes it easier to tune out the noise, resist where our primitive minds would lead us, and learn to  get comfortable with the uncomfortable. And perhaps this is the greatest survival skill of all.

 

Photo by Luiz Rogério Nunes on Unsplash