The Money Game & The Human Brain

Jason Zweig, a neuroscience and Benjamin Graham expert, re-published an article last year entitled: “Ben Graham, The Human Brain, And The Bubble.” The entire article is a worthy read but there were a few points in particular he made that are just as relevant today as they were when he wrote the original essay in 2003.

“At the peak of every boom and in the trough of every bust, Benjamin Graham‘s immortal warning is validated yet again: ‘The investor’s chief problem — and even his worst enemy — is likely to be himself.’”

I have written about the psychological issues which impede investors returns over longer-term time frames in the past. They aren’t just psychological, but also financial. To wit:

“Another common misconception is that everyone MUST be saving in their 401k plans through automated contributions. According to Vanguard’s recent survey, not so much.

The average account balance is $103,866 which is skewed by a small number of large accounts.
The median account balance is $26,331
From 2008 through 2017 the average inflation-adjusted gain was just 28%.

So, what happened?

Why aren’t those 401k balances brimming over with wealth?
Why aren’t those personal E*Trade and Schwab accounts bursting at the seams?
Why are so many people over the age of 60 still working?

While we previously covered the impact of market cycles, the importance of limiting losses, the role of starting valuations, and the proper way to think about benchmarking your portfolio, the two biggest factors which lead to chronic investor underperformance over time are:

Lack of capital to invest, and;
Psychological behaviors

Psychological factors account for fully 50% of investor shortfalls in the investing process. It is also difficult to ‘invest’ when the majority of Americans have an inability to ‘save.’”

“These factors, as shown by data from Dalbar, lead to the lag in performance between investors and the markets over all time periods.”

While “buy and hold” and “dollar cost averaging” sound great in theory, the actual application is an entirely different matter. Ultimately, as individuals, we do everything backwards. We “buy” when market exuberance is at its peak and asset prices are overvalued, and we “sell” when valuations are cheap and there is a “rush for the exits.”

Behavioral biases are an issue which remains little understood and accounted for when individuals begin their investing journey. Dalbar defined (9) nine of these behavioral biases specifically:

Loss Aversion – The fear of loss leads to a withdrawal of capital at the worst possible time.Also known as “panic selling.”

Narrow Framing – Making decisions about on part of the portfolio without considering the effects on the total.

Anchoring – The process of remaining focused on what happened previously and not adapting to a changing market.

Mental Accounting – Separating performance of investments mentally to justify success and failure.

Lack of Diversification – Believing a portfolio is diversified when in fact it is a highly correlated pool of assets.

Herding– Following what everyone else is doing. Leads to “buy high/sell low.”

Regret – Not performing a necessary action due to the regret of a previous failure.

Media Response – The media has a bias to optimism to sell products from advertisers and attract view/readership.

Optimism – Overly optimistic assumptions tend to lead to rather dramatic reversions when met with reality.

Cognitive biases impairs our ability to remain emotionally disconnected from our money.

But it isn’t entirely your fault. The Wall Street marketing machine, through effective use of media, have changed our view of investing from a “process to grow savings over time” to a “get rich quick scheme” to offset the shortfall in savings. Why “save” money when the market will “make you rich?”

As I addressed in “Retirees Face A Pension Crisis Of Their Own:”

“Using faulty assumptions is the linchpin to the inability to meet future obligations. By over-estimating future returns, future retirement values are artificially inflated which reduces the required saving amounts need by individuals today. Such also explains why 8-out-of-10 American’s are woefully underfunded for retirement currently.”