Why can some people risk a year’s salary based on an investment tip they receive from a friend, while others are too nervous to invest in the markets at all? Is there a physiological reason – something in investors’ brains – that causes people to manage their money a certain way?
Years ago I had the opportunity to meet up with Dr. Ravi Menon, Canada Research Chair in Functional and Molecular Imaging at Western University, to try and understand what is happening in our brains when we make financial decisions – and how we can use this information to our advantage. What Dr. Menon explained to me is that the human brain was hard-wired thousands of years ago to make split-second decisions based on the information that was immediately available. If our ancestors saw a tiger running towards them, their instincts told them to run away in order to stay alive. No advice was needed since the brain instinctively values short-term gain.
There is an interesting correlation here to investing.
Money is always emotional, so it’s not surprising that there can be a “battle of the brain” between classic greed versus fear. There’s also the “fight or flight” battle where fear can be a major obstacle to successful investing, causing some to behave irrationally and do things they might regret. Sometimes you feel very happy with an investment decision you made and might take on more risk trying to replicate that feeling again and again. And finally, some may remember what happened before, where negative memories from an experience like the recession can cause investing paralysis.
The decisions we make that affect our money can be fraught with emotion, especially during periods of volatility so it would be silly and unrealistic to try to eliminate that emotion entirely. But that doesn't mean you do nothing and sit in cash. Investing in any environment makes sense if you develop a plan and stick to your plan. Planning over emotion helps to increase the odds of adopting good habits and sticking with them, and is often supported when finding an advisor you trust.
This is likely going to be put to the test yet again. In May, when Manulife conducted its semi-annual Investor Sentiment survey, which was released Monday, found investor sentiment jumped the most in five years as oil prices seemed to rebound, the dollar was stronger and markets were higher. That was then and this is now, with both oil and the dollar lower while the TSX is up approximately 12 per cent year to date. This positive sentiment could be challenged yet again.
I recall Dr. Menon telling me, “remarkably, brain imaging studies can show us how measured advice from trusted sources can tilt the brain’s emotional decision-making biases towards a more long-term view.” And so I conclude, having a long term perspective and plan helps to reduce one of the most detrimental investment strategies – emotional investing.
There is a difference between being emotional and irrational when it comes to money.
The Manulife survey also found that millennials felt optimistic about their futures. Younger Canadians (25-34) are feeling more optimistic about their financial situations than older Canadians, with 40 per cent feeling they would be in a better financial situation than they were two years ago. Meanwhile, only 25 per cent of respondents aged 55 or older feel the same way. Also this cohort are less likely than other age groups to plan renting over owning a home (52 per cent) and more likely (39 per cent) to buy a house in the next 12 months.
It will be interesting to see what the next six months bring.
As the Chief Financial Commentator for CTV News, Pattie Lovett-Reid gives viewers an informed opinion of the Canadian financial climate. Follow her on Twitter @PattieCTV