Don’t Let Your Amygdala Guide Investment Decisions

In Raiders of the Lost Ark,  Indiana Jones feared snakes.  Bry Loyst, proprietor of Indian River Reptile Zoo, is not afraid of snakes.  Respectful but not fearful.

What is the difference?

Bry knows more and understands the signs.  He knows the tendencies of his creatures and he knows their strengths and their limits.  He knows his own.  When you know enough, you respect,  but do not fear.  When you know enough, you can prepare and know when to change behaviour.  When you know enough, you are reasonably safe.

Snakes and other reptiles are a rare confrontation for most of us, so we tend not to learn much and react fearfully as the result.  Same thing for investors in the stock market.

Sun Life Global Investments conducted a reasonable survey recently.  The findings are a little counter-intuitive.  You can see the report here.

  • Looking forward five years, participants were slightly more pessimistic than optimistic.  42% to 37%
  • Same general idea for the stock market.  Slightly pessimistic.
  • Of all age groups, millennials and Gen X were the most pessimistic.
  • Millennials were three times more likely to have sold investments when the market fell than persons over 67.  Gen X about twice as likely.

The question becomes why would those with the longest investment time horizon fear volatility?  As with fear of reptiles, the answer could be because they do not know enough.

Fear of losing money in the stock market is an ancient brain response.  The amygdala a very old part of the brain and is heavily involved with decision making and emotional responses.  It is not at all good at logic.  Fear is primitive and very powerful.  Volatility induces fear, but only when you look.  Your higher brain would notice volatility matters only if you are going to take the money back to use for something else, so why look?

A young person who fears the loss of value in their portfolio is not actually understanding the process.  You cannot lose “money” in your portfolio.  The value could change downwards, but that is not the same thing as losing money.  You gave up your money when you bought the assets.  What you have is the fractional share of a business and an option to exchange that for money.  The stock market values that option, not the assets underlying it.  So when the market is down you must ask yourself. “Did the value of my assets fall, or did the market pricing mechanism change?”

Microsoft has in the past 12 months, traded between $56 on the high side and $40 on the low side.  It was pretty much the same business throughout.  If you sell when it goes down and buy when it is up, you will inevitably lose most of your money.

The same is true for the market taken as a whole. It is made up of businesses.  A fraction of a business has value and once people notice the idea of business value, the price will tend to become noise.  Notice the difference between price and value.

In 1919 Coca-Cola became a public company at $40 per share.  That share with dividends invested, today is worth more than $10 million. The hard part is that a year after issue, in 1920, the shares were worth only about $20 each.  I suspect many people sold their shares because they feared a greater loss and few bought because it looked risky.  For those who did not look, or bought more because they understood the “business,” life has been good, albeit volatile.

Fear and greed are poor investment advisors. You cannot understand your portfolio by looking at stock prices.  It is a fool’s game and a very expensive one. Find a professional to help you learn, so you can manage your amygdala.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772

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3 Responses to Don’t Let Your Amygdala Guide Investment Decisions

  1. Mark Benkovic says:

    The most recent DALBAR study (2015) tells a more realistic story, which surpasses mere fear and greed. It shows returns over the past ten years to be very low ( I.e. stocks averaged barely over 4 per cent, and balanced funds and bond funds averaged only about 2 per cent). After taxes and real inflation the average investor I public stock and bond markets lost purchasing power.

    • Dalbar relies on market derived prices which as pointed out in the article have little to do with real value. Worse, averages are misleading. If one bought an established business instead of stock they would be okay. EG. John Deere has doubled and paid dividends all the time. 3% currently. Walmart is up 50% or so with decent dividends. Johnson and Johnson has doubled again with a dividend that is over 2.5%. It is not hard to find excellent businesses that are not subject to the fashion that defines the stock market. You do not have to look hard to find them. Pepsico, Coke, Royal Bank up 50% with a 4% dividend, Microsoft double with a dividend, Oracle triple with a dividend. How about MasterCard 20x with a small dividend. Why even notice fads, fashion, politically affected businesses and resource companies that are exposed to both the stock market and the commodity market. You might do great but then again maybe not. Business quality matters more than the stock market price.

  2. The value of the company does not change nor the assets.Clients need to understand the market only reflects the share price not the value of the company.The fluctuations that we see everyday reflect the activity of the stock market and has no direct link to the companies operations and assets.Since early on in my life I have observed the steady climb and growth of big companies like Coca Cola,Sasol,Vodacom,MTN and others whilst their shares fluctuate they have grown from strength to strength and expanded to other countries with ease.Better to use experts in this field for better results.Thanks Don I hope people learn as much as we do from you and other experts.Investing is like planting you can not wait for the favorable season or weather you plant when the time is right and be patient without knowledge whether it will rain or not.It is like surfing you will not catch the big wave outside on the beach you have to be inside.

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