Investing requires objective fact gathering and subjective decision making. Ideally, subjective judgments are free from the deleterious effects of emotions. One emotion plaguing investors is anxiety. Recent regional research by CFA Institute showed investors were concerned about the potential for another bubble in the GCC region, especially following Dubai’s successful bid to host Expo 2020.
Aren’t emotional responses, such as anxiety, hardwired into our brains?
The evidence strongly suggests this is correct. Much research has demonstrated that the brain’s two amygdalae, located mid-brain, are the source of instinctual, hardwired responses, like “flight or fight.” These responses are almost instantaneous and do not involve analytical judgment. Anxiety is difficult to control as it operates subliminally. Any investor that has seen an investment decline significantly in just one trading session knows this response well: panic.
Before the modern era these responses to the natural environment saved us, as panic and consequent flight improved our chances of survival. But in investing, anxiety of this sort leads to poor choices, such as selling with the herd when perhaps the better choice is to buy since prices in a panic-inducing sell off are now lower. Anxiety associated with financial loss always lurks within the brain.
Why is it so difficult to go against the investment herd?
The amygdala fires strongly when we make a decision we know consciously goes against a group decision. In other words, standing up for oneself causes anxiety. Researchers have found when groups of people sit and watch films together brains eventually synchronize with one another, with various parts of everyone’s brain acting in concert with one another. Implicit in this is the notion of a collective consciousness or entrainment of consciousness. That, in turn, helps explain why it is so difficult for investors to go against the grain even though it is common knowledge that investors have a herd mentality. There is an emotional load associated with standing up for one’s beliefs.
How are human beings hardwired to respond to the unknown?
Numerous studies show the human mind is built to be anxious about the unknown and more comfortable with less ambiguity. In financial markets, companies more widely followed by analysts have higher trading volumes. A preference for low ambiguity is also shown by the tighter earnings estimates are for a given company — that is, the less ambiguous the expected performance — the higher the price of that stock, on average. Again, the amygdala seems to be the part of the brain in operation in these moments. The lesson to be drawn is that we prefer predictability.
If these emotions are hardwired then how do we overcome them?
Human beings are seemingly unique among animals in that we are able to use our minds to overcome these hard-wired instincts. Brain researchers emphasize using the powers of the pre-frontal cortex (aka the reflective brain). Unfortunately, the pre-frontal cortex is more taxing to use than the amygdala. But with training people can learn to overcome emotions.
This process is similar to learning to bite your tongue in social situations where a flippant response to an outrageous statement may be detrimental. Just like any mental aptitude using the reflective brain requires consistent and conscious exercise to become stronger.
Practically, what can we do to overcome anxiety?
Get it off your mind: When you feel anxious stop what you are doing and instead do something that relaxes and rejuvenates you. For example, going for a run or walk, putting on your iPod and listening to some of your favourite music, meditating, swimming, and so on. Use your words: Words make use of the prefrontal cortex. Therefore, take a moment to write about the emotions you are experiencing and about the facts of a situation. This should help calm your amygdala and activate the reflective part of your brain.
Track your feelings: Gain consciousness of your emotions as they are often contra indicators. Numerous investors have made successful careers out of buying investments when the majority are sellers, and selling when the majority are buyers.
Get away from the herd: Record your own views about an investment before engaging in a discussion. This helps anchor your thoughts against the forces of group think. Seek the opinion of someone you respect who is not part of the group. This helps you see your opinion relative to the group’s opinion.
Any caveats?
The goal is not to shut down the amygdala as sometimes it does provide the correct response. Instead investors should strive to have conscious control of their entire mind, the amygdala and the pre-frontal cortex.
— Jason A. Voss, CFA, a Content Director of Fixed Income, Behavioral Finance, Quantitative Methods and Corporate Finance at CFA Institute, and Amer Khansaheb, president of CFA Society Emirates