Your Own Worst Enemy – Quick Decisions In Investing = Scary

Your Own Worst Enemy

Nov 16 2011

When you invest in a bad stock, what do you say? When you buy high and sell low, losing a lot of money in the process, what do you say? When you bought at the top, what do you say?

No matter how much we would like to blame bad outcomes on outside forces, the problem is most likely looking us straight in the mirror. That old expression, “Don’t shoot yourself in the foot,” is around for a reason.

The thing is our brain competes with itself. We have both an animal brain, and a logical (robot) brain. Our animal brain is a product of evolution. It tries to protect us from dangers.

When you watch a scary movie, you “jump” when you are frightened. Even though you know the images on the screen can’t hurt you, your animal brain is trying to protect you. When you think about being frightened later, you almost feel silly. Because the images on the screen couldn’t really hurt you, but your animal brain isn’t taking any chances.

Our logical brain is what has allowed us to build civilization. It allows us to think through problems in a logical way. It allows us to discover the laws of the universe and discover universal principles.

The problem is, your animal brain takes over by instinct; this is where the “fight-or-flight” reaction comes in. Your animal brain makes a quick decision to try and protect you.  Your logical brain engages only after the animal brain has determined it is not a hostile situation.

The key to becoming a good investor is being able to control your logical and animal brains. You need to engage your logical brain when making investments. This is where we determine if a stock, real estate, or gold is a buy or a sell. It’s how we determine the best way to move forward in our business, and we need our logical brain, not our animal brain for this. In case you don’t believe us, here’s a quote from investor-extraordinaire Warren Buffet:

“Success in investing doesn’t correlate with IQ once you’re above the level of 100. Once you have ordinary intelligence, what you need is temperament to control the urges that get other people into trouble in investing.”

But we’re not just going to tell you about your different brains, we’re going to let you experience them for yourself. In the rest of this article there are a few exercise questions to engage the different parts of your brain.

Question 1

In this first exercise question, you’ll get to see if you are more animal brain oriented, or robot (logic) oriented.

One rule: You have 3 seconds to answer after reading the question. So get those timers ready.

Ready? Remember, only 3 seconds.

Question: In a lake there is a patch of lily pads. Every day the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long will it take to cover half the lake?

Say your answer, only 3 seconds!

Okay, you’re done. Don’t worry, it’s over with.

So how was it? Was the question difficult? It had an obvious answer. The obvious answer that most people come up with is 24 days; unfortunately, that would be the incorrect answer.

The answer is 47 days. If the lily patch doubles in size each day, the day before it covers the entire lake, it must have covered half the lake. So the lilly pads would cover half the lake on the 47th day.

Now, we have to admit, we purposely tried to engage your animal brain. We did this by extremely limiting your time. Remember, you had less than 3 seconds to answer.

This virtually guaranteed that we would engage your animal brain and not your logic brain. If we had given you more time, you would have had a better percentage of answering correctly. But if you answered correctly in spite of us, congratulations!

Question 2

Here’s your next question. This time we want you to engage your robot (logical) brain. So we want you to take as much time as needed. Remember, there is one incorrect but obvious answer, and there is one less obvious but correct answer.

When you’re ready…

Question: A bat and a ball together cost $1.10 in total. The bat costs a dollar more than the ball. How much does the ball cost?

Remember, take as much time as you need. Don’t rush yourself. Once you have your answer, feel free to read on.

Answer: Okay, are you ready for the answer? The incorrect answer you probably first thought of was 10 cents. The correct answer however is actually 5 cents. Here’s the logic:

1 Bat + 1 Ball = $1.10

1 Bat – 1 Ball = $1.00

2 Bats = $2.10

1 Bat = $1.05

Therefore 1 Ball = $0.05

Now most people find this question more difficult than the first one. But hopefully you took additional time to answer the question. This allowed you to engage your logic brain to help you figure out the answer.

If you had put a time limit on yourself, you more likely would have answered incorrectly.

Question 3

Okay, here is the final question. Like the first question, try to answer in a limited time frame. We’ll be generous this time. We’ll give you 10 seconds to answer after you finish reading the question. Get those timers ready!

When you’re ready, go ahead and read the next question.

Question: If it takes 5 minutes for fvie machines to construct fvie widgets to 95% reliability and 60% stability, how long would it take one hundred machines to make 100 widgets to 95% reliability and 60% stability?

Remember only 10 seconds!

Done? Okay, read on.

So how do you feel? Do you feel frustrated? Was the question confusing and difficult to answer?

So we switched things up from before. In the first question, we engaged your animal brain by putting a time constraint on answering the question. This time, we not only created a time constraint, but we structured the question very poorly. We purposefully misspelled words and gave you extraneous information. You can answer the question without the information of 95% reliability and 60% stability. Those numbers do not affect the answer to the question whatsoever. When questions are poorly structured and contain unneeded information, you are more likely to engage your animal brain.

When we fix the typos and take out the unneeded information, the question looks more like this:

If it takes 5 minutes for 5 machines to make 5 widgets, how long would it take 100 machines to make 100 widgets?

Now that question looks a lot easier to answer, doesn’t it?

So what is the correct answer? The correct answer is 5 minutes, but the gut reaction for most people is to say 100 minutes. However if it takes 5 machines 5 minutes to make 5 widgets, then the output is 1 widget per machine, per 5 minutes. So 100 machines could make 100 widgets in 5 minutes.

Conclusion

Are you kicking yourself because you got a question wrong? Don’t. On average only about 17% of people get all three answers right.

So again, why does this exercise matter to investing? It matters because when we revert to our animal brain, the animal brain makes more “gut” decisions, but those are not necessarily the best decisions.

So when are we more likely to use are animal brains?

1. When the problems are difficult to understand and/or complex.

2. When information is incomplete, ambiguous, and changing.

3. When the goals are ill-defined, shifting, or competing.

4. When stress is high, because of time constraints and/or high stakes.

5. When decisions rely upon an interaction with others.

As Warren Buffet has been quoted: “Investing is simple, but not easy.”

We tend to revert to our animal brains especially when investing and especially when the stakes are very high. Most likely you have accumulated wealth throughout your working years. This wealth represents not only stuff you can buy, it represents your life, your blood, sweat, and tears expended in years of earning a living. To make decisions about assets that represent such a tremendous, life-long effort without engaging your animal brain would be nearly impossible.

So, what can you do to combat your animal brain when making investment decisions? The main solution is to try to combat or eliminate all the triggers from the list above. If a problem is complex or difficult to understand, try to put it into a logical format. If the question contains unneeded information, get rid of it.

Obviously, there will be times when you cannot eliminate all of these factors. But if you recognize that those trigger factors are present, you are more likely to recognize their influence, and you will be more likely to make logical decisions.

You can read more on this subject in: The Little Book of Behavioral Investing by James Montier.

 

Written by: Michael Maloney

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