Are you still reeling from the recent Wall Street rollercoaster ride? I get it. The Dow fell more than 3200 points – about 10% – in just a few trading sessions. That kind of volatility can feel like a freefall. Luckily, it wasn’t. In the end, this tumble was painful, but not terminal. Still, folks are shaken and scared.
I’m a big believer that long-term commitment is a necessary ingredient for successful investing. In the wake of every correction, my message has been the same: Stay calm. Corrections are a normal part of the market’s circle of life.
But that’s not what I want to talk about today. I want to take a moment and acknowledge that corrections like this, and bear markets in general, create real emotional responses and even pain.
The reality is that February had the worst market week since 2009. It was a wild ride, to say the least. This wasn’t a brush-your-shoulders-off type of dip or baby correction. It was more of the gut-punch, are-we-falling-off-the-cliff variety. And we are all still feeling it.
Most people cringe at the sight of their money seemingly washing way. You built your portfolio over the past 40 years, and when it drops, you feel it. The more you lose, the more it claws at you. But the bottom line is that no matter if it’s a $20, $1,000 or $50,000 loss, it hurts.
There is a burgeoning field of science devoted to the interplay between our finances and our emotions. Neuroeconomics, as it’s called, combines elements from neuroscience, psychology and economics to better understand financial decision making.
One key player in this research is veteran financial journalist, Jason Zweig. In his book Your Money and Your Brain, Zweig details how both financial losses and gains have a profound physical effect on the brain and body. For example, financial losses are processed in the same area of the brain as mortal danger. This means that when we lose money, we feel it as intensely as if our lives were at risk.
That makes sense. In today’s the world, money equals survival. Having at least a baseline amount of money (for food, shelter, clothing) equates to subsistence. This point may explain the mortal fear correlation.
All of our financial pleasure/pain originates in the insular cortex, a part of our brain associated with emotions. There have been a multitude of studies that measure the emotion related to winning or losing money. Nothing lights up the insular cortex during a brain scan like the emotion we feel about our money. This is particularly true when we suffer a loss. In fact, we feel four times the pain when we lose a dollar as we feel pleasure when we gain one.
Considering the neuroscience and psychology behind how we conceptualize finances, we can understand why, in the middle of corrections, some folks cash out and lock in their losses. They are scared. They are operating in fight or flight mode. No matter how rash or irrational it may seem to someone on the outside, these folks are functioning from a very human, very primal place.
I totally understand. Weeks like these just aren’t pleasant for most investors. They are in your face and frightening. It’s much more enjoyable and placid when the escalator is steadily climbing week after week, and we are moving towards long-term growth. But, as we all know, markets move in both up and down. Now that we’re headed in the other direction, things feel unsettled. That’s why I think it’s important to understand the science behind what we’re experiencing.
With these concepts in mind, remember too that, while a baseline amount of money does provide security, it only buys us happiness up to a point. Then, our happiness plateaus, no matter if we gain $100,000 more or $1 billion more.
It is a benefit to us all to remember the discipline we need to be successful long-term investors. History tells us that corrections and dips happen, bringing both pain and opportunities. In these moments, we would all do well to remember that the definition of courage isn’t the absence of fear. Courage is doing what must be done, despite the fear.
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