Minding Your Money

But risk aversion doesn't always lead to the highest rate of return. For instance, I have a friend who won't sell stocks her father bought decades ago. Why is familiarity so comforting?
For many years, AT&T was the most widely held stock in America, primarily because people inherited it from their parents. A lot of stocks are like family heirlooms. It's hard to let go because the brain is like modeling clay. Once you make an impression on it, it's there. To sell your dad's AT&T is like selling dad. The best advice you can give someone like your friend is to suggest not that she sell dad's stock, but that she buy more of other stocks.

You cite research showing that people feel fear whenever they make a decision that goes against the crowd—like buying low and selling high. Are we afraid of being wrong or of social rejection?
In one study, people [undergoing] brain scans were asked whether they agreed or disagreed with a computer or another person in response to a test question. When [there was agreement], the activity in their prefrontal cortex—where we do analysis—went down. The task became a mindless choice.

Where it got interesting was when people [disagreed]. Then there was intense activity in the prefrontal cortex and firings in the amygdala, one of the brain's fear centers that is also sensitive to social rejection. Disagreeing with the computer was significantly less stressful than disagreeing with a person.

That suggests that monitoring online forums or financial news only makes it harder to buck the crowd and sell high, when everyone else is buying.
It's easy to hear from a crotchety crank online, but to find substantive content that goes against the grain is no easier online than anywhere else, and you may get swamped. It's hard for the contrarian voice to float to the surface.

Another problem with online forums and financial news is that the telling anecdote dominates the statistical evidence. Anecdotes appeal to the intuitive, emotional brain. Statistical information doesn't speak to the emotions and that's why people don't act on it. You could tell people that one of the safest ways to travel is by commercial airliner. In fact, people already know that. But if they see footage of a plane crash on CNN, forget about the statistics. They'll be happy to drive without a seatbelt after drinking two beers, but they won't get on a plane.

So what's a return-hungry investor to do?
Investing is like dieting. There's a million dieting books and videos and Web sites. But everybody already knows exactly how to lose weight—eat less, exercise more. It's simple. But it's not easy in a world full of greasy food and soft couches. Also like dieting, investing is simple, but not easy. What makes investing hard is all the emotional distractions. If people could remember that it's simple and follow the few rules that can enable you to put a simple plan in place, we'd never need to worry. You don't need to beat the market to be a successful investor. If you measure success that way, you've already set yourself up for failure.

© 2007