Silence is golden

Posted by on May 9, 2013 @ 2:15 am in Investing

Last Christmas, I bought my son a pair of noise-canceling headphones. Now, even as I raise my voice to a shout, he can’t hear me above whatever is rattling around inside his head.

In short, he’s on his way to becoming the greatest investor of his generation.

Assault on the amygdala

The financial markets are a noisy spectacle. A generation ago, however, the noise was faint—a whisper from the stock tables in the daily newspaper or a weekly word of wisdom delivered in Louis Rukeyser’s baritone on public television.

Today, the noise comes at us in surround sound, the volume jacked up to 11. If we’re investing without high-end headgear, the 24/7 cycle of news and punditry can induce physiological effects that undermine our ability to stick with a long-term investment program.

“Deep in your brain, level with the top of your ears, lies a small, almond-shaped knob of tissue called the amygdala,” writes Jason Zweig in Your Money & Your Brain, an exploration of the neurological impulses that drive our investment decisions.

“When you confront a potential risk, this part of your reflexive brain acts as an alarm system—generating hot, fast emotions like fear and anger that it shoots up to the reflective brain like warning flares.¹

The same flood of hormones that prompted our forebears to flee from saber-toothed tigers can be activated by scary words and vivid images of risk. “A television broadcast from the floor of the stock exchange on a bad trading day, for example, combines a multitude of clues that can fire up the amygdala: flashing lights, clanging bells, hollering voices, alarming words, people gesturing wildly,” Zweig explains.²

Since the 2008–2009 financial crisis, we’ve heard a lot of hollering. Cash flow data suggest that the real traumas, and perhaps the uncertainty and speculation about what disaster might befall us next, have changed our behavior, making us less willing to assume risk. In 2006 and 2007, before the onset of the crisis, investors contributed a net $500 billion to stock mutual funds, including ETFs.

In the five years that followed, as headlines chronicled the collapse of Lehman Brothers, the European debt crisis, the U.S. debt-ceiling debacle, the prospect of a leap from the fiscal cliff, and other dangers, investors contributed less than one-third as much.

 

Source: Strategic Insight

Source: Strategic Insight

 

Muting fear

How can we resist the impulse to act on fear? “Use your words,” Zweig writes. “[T]he more complex cues of language activate the prefrontal cortex and other areas of your reflective brain. By using words to counteract the stream of images the markets throw at you, you can put the hottest risks in cooler perspective. ³

I’m partial to the words used in Vanguard’s principles for investment success:

  • Create clear, appropriate investment goals.
  • Develop a suitable asset allocation using broadly diversified funds.
  • Minimize cost.
  • Maintain perspective and long-term discipline.

When you feel compelled to change your investment behavior, ask yourself why. Have your goals and circumstances changed? Is the latest bad news so bad that it has radically changed the risks and returns associated with your chosen asset allocation? History suggests that, more often than not, the answer is no.

And if your words don’t work, try noise-canceling headphones.
 

 

¹ Zweig, Jason, 2007. Your Money & Your Brain. New York: Simon & Schuster, p. 159.

² Ibid., p. 162

³ [1]. Ibid., p. 171

Note: All investing is subject to risk, including the possible loss of principal. All investments, including a portfolio’s current and future holdings, are subject to risk.

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