Why, then, do investor find Mr. Market so seductive? It turns out that our brains are hardwired to get us into investing trouble; humans are pattern-seeking animals. Psychologists have shown that if you present people with a random sequence - and tell them that it's unpredictable - they will nevertheless insist on trying to guess what's coming next. Likewise, we "know" that the next roll of the dice will be a seven, that a baseball player is due for a base hit, that the next winning number in the Powerball lottery will definitely be 4-27-9-16-42-10- and that this hot little stock is the next Microsoft.
Groundbreaking new research in neuroscience shows that our brains are designed to perceive trends even where they might not exist. After an event occurs just two or three times in a row, regions of the human brain called the anterior cingulate and nucleus accumbens automatically anticipate that it will happen again. If it does repeat, a natural chemical called dopamine is released, flooding your brain with a soft euphoria. Thus, if a stock goes up a few times in a row, you reflexively expect it to keep going - and your brain chemistry changes as the stock rises, giving you a "natural high." You effectively become addicted to your own predictions.
But when stocks drop, that financial loss fires up your amygdala - the part of the brain that processes fear and anxiety and generates the famous "fight or flight" response that is common to all cornered animals. Just as you can't keep your heart rate from rising if a fire alarm goes off, just as you can't avoid flinching if a rattlesnake slithers onto your hiking path, you can't help feeling fearful when stock prices are plunging.
In fact, the brilliant psychologists Daniel Kahneman and Amos Tversky have shown that the pain of financial loss is more than twice as intense as the pleasure of an equivalent gain. Making $1,000 on a stock feels great - but a $1,000 loss wields an emotional wallop more than twice as powerful. Losing money is so painful that many people, terrified at the prospect of any further loss, sell out near the bottom or refuse to buy more.
That explains why we fixate on the raw magnitude of a market decline and forget to put the loss in proportion. So, if a TV reporter hollers, "The market is plunging - the Dow is down 100 points!" most people instinctively shudder. But, at the Dow's recent level of 8,000 that's a drop of just 1.2%. Now think how ridiculous it would sound if, on a day when it's 81 degrees outside, the TV weatherman shrieked, "The temperature is plunging - it's dropped from 81 degrees to 80 degrees!" That, too, is a 1.2% drop. When you forget to view changing market prices in percentage terms, it's all too easy to panic over minor vibrations. (If you have decades of investing ahead of you, there's a better way to visualize the financial news broadcasts: see---).
In the late 1990s, many people came to feel that they were in the dark unless they checked the prices of their stocks several times a day. But, as Graham puts it, the typical investor "would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgment." If, after checking the value of your stock portfolio at 1:24 p.m., you feel compelled to check it all over again at 1:37 p.m., ask yourself these questions:
- Did I call a real-estate agent to check the market price of my house at 1:24 p.m.? Did I call back at 1:37 p.m.?
- If I had, would the price have changed? If it did, would I have rushed to sell my house?
- By not checking, or even knowing, the market price of my house from minute to minute, do I prevent its value from rising over time?
The only possible answer to these questions is of course not! And you should view your portfolio the same way. Over a 10- or 20- or 30- year investment horizon, Mr. Market's daily dipsy-doodles simply do not matter. In any case, for anyone who will be investing for years to come, falling stock prices are good news, not bad, since they enable you to buy more for less money. The longer and further stocks fall, and the more steadily you keep buying as they drop, the more money you will make in the end - if you remain steadfast until the end. Instead of fearing a bear market, you should embrace it. The intelligent investor should be perfectly comfortable owning a stock or mutual fund even if the stock market stopped supplying daily prices for the next 10 years.
Paradoxically, "you will be much more in control," explains neuroscientist Antonio Damasio, "if you realize how much you are not in control." By acknowledging your biological tendency to buy high and sell low, you can admit the need to dollar-cost average, rebalance, and sign an investment contract. By putting much of your portfolio on permanent autopilot, you can fight the prediction addiction, focus on your long-term financial goals, and tune out Mr. Market's mood swings.
Ref: Intelligent Investor by Benjamin Graham
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