As the legendary money manager Benjamin Graham once observed, “The investor’s chief problem, and even his worst enemy, is likely to be himself.” You may feel the urge to buy or sell a stock or bond in the pit of your stomach, but the action really starts upstairs, right behind the eyes.
Although the Homo sapien’s brain isn’t the biggest brain among all species — the elephant’s and some whales’ brains are bigger — it’s by far the most efficient. It has the best information processing capacity owing to its high cell density in the neo-cortex and much smaller distances between neurons.
But since investing is a relatively recent activity, our species is better adapted to surviving as hunter-gatherers than at buying financial assets low and selling them high. The neurology that allowed us to survive and thrive in the perilously isolated physical world before farming and civilization doesn’t serve us as well in deciding how, when and where to put our money on the line.
A deeply ingrained bias toward risk aversion — thus promoting physical survival — is the neural driver behind the tendency of investors to sell low.
In Your Money and Your Brain, author and journalist Jason Zweig writes that humans “are wired to crave what looks rewarding and shun what seems risky.” In other words, go ahead and take down the sickly wildebeest, but pass on the healthy-looking saber-toothed tiger.
An expert in the emerging field of neuroeconomics, Zweig does a masterful job of explaining how our complex neurology served — and serves — us well in most aspects of daily life but often lets us down when we invest.
Specifically, two almond-sized clumps of neurons in the primordial section of the brain known as the amygdala (the so-called fear factory) wrestle with another area called the nucleus accumbens, which fires frantically when sensing opportunity. That makes stocks riding high appear safe and thus rewarding.