Fear, Greed and Your Brain - Show 134

Thursday, August 21, 2014 6,618 views

Jason Zweig, a columnist for The Wall Street Journal, offered his opinion on how humans are not hardwired to be good investors. In his book Your Money & Your Brain, Mr. Zweig dissects the human brain to discuss how humans are motivated to make decisions - mainly out of fear and greed. These emotions are valuable attributes for survival, but can become a hindrance when dealing with money. Specifically, Zweig states, "for most purposes of our daily life, your brain is a superbly functioning machine, instantly steering you away from danger while reliably guiding you toward basic rewards like food, shelter, and love. But that same intuitively brilliant machine can lead you astray when you face the far more challenging choices that the financial markets throw at you every day." Emotions such as fear or greed often trump our logic, especially when fueled by certain behavioral biases, and leading us all to the same conclusion – we are really not as smart as we think we are.

What causes us to have such poor judgment? Some of the more prominent behavioral biases include: regret avoidance, confirmation errors, familiarity bias, and irrational escalation.

Every year, DALBAR releases their Quantitative Analysis of Investor Behavior (QAIB) study, measuring the impact of investor behavior on investment returns. As this chart indicates, the return received by the average equity investor severely lagged both the S&P 500 and IFA's Index Portfolio 100. Apply dollar amounts to those percentages and it reveals the startling differences in accumulated wealth based on a starting investment of $100,000. DALBAR reports that psychological factors account for the bulk of this shortfall.

IFA’s advisors help control those psychological factors. As much as we manage wealth, we also manage emotions to help investors stay the course. 

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