When people are shown the picture above and asked what they see, the response is “a black dot”. Hardly ever do people say that they see a lot of empty white space. We seem to have a default to focus on things that stand out rather than things that all blend. This somewhat negative focus occurs because our reptilian brain is programmed to alert us to potential threats in the environment so as to warn us and help keep us safe. We notice the dot because it stands out as different. Anything that is different from the environment could be a possible threat. It may be an approaching bear in the distance. It is the desire to stay alive, that leads us to default to the negative assumption. (Better be wrong and safe than unaware and dead!).
This tendency also arises in the world of finance. The players have changed, but the rules are the same, don’t get eaten (don’t lose money). Today we are not running from bears and tigers to keep safe. Instead, we are running from (avoiding) financial losses to keep safe. Money represents survival in today’s world.
Our basic human impulse then is to hate losing (being eaten by a wild animal) more than we like winning (staying out of sight) as it relates to financial investments. Daniel Kahneman won the 2002 Noble Prize for economics for his theory that showed this phenomenon. When conditions are uncertain, the theory states that people have an irrational tendency to be less willing to gamble with profits than with losses. We are happy for an hour when we win $50 but sulk all day when we lose $50. It is natural that we would have this default reaction because money is now necessary for survival so we don’t want to lose (get eaten) especially when faced with uncertainty. Not losing money means survival. Losing money means reduces chances of survival, as a result not losing takes precedence over everything else.
People make decisions based on gains and losses rather than the final outcome. This may not always be the best strategy to ensure financial success, but because survival is built into our DNA we default to preserving gains and avoiding losses. When investors enter the stock market the objective is to make gains and avoid losses instead of placing emphasis on the value of the stock. This results in selling quickly to capture profits and holding on to losses instead of selling them off quickly. We hold on to the losses in the hope of recovering which usually never happens and instead it drags us deeper in the hole. Another irrational behaviour of when we let the reptilian brain (our default) takeover is where people don’t invest because they don’t want to pay taxes on the earnings. They ignore the fact that there is still an after tax gain. For many, however, the aversion to loss is so strong, that the satisfaction they receive from the extra earnings would not compensate them for the feelings of loss which they incurred because of paying the taxes.
When people hate losing more than they like winning, it affects the quality and the quantity (in dollar terms) of our lives. The quality of our life is affected when we don’t take chances and try new things because we are afraid of loss (or failure). This prevents us from really knowing what our capabilities are because it dampens our spirit. Also when we play it safe, we can really miss out on significant opportunities not only for personal growth but also the chance of making financial gains.
The question remains, how do we fight our natural fight or flight instincts when it comes to finance? It all starts in our head, quite literally. We need to get out of the reptilian brain and let our neocortex takeover and reframe the situation. In the case of a loss which is what people are most terrified off, we have to reframed the loss into a positive experience. We have to see it as a positive event that teaches us some valuable lessons. Lessons such as: identifying what they shouldn’t do next time, the need for more careful analysis and maybe we learn not to take financial advice from our barber. When we reframe a negative experience into a good one, the result is that we will cut our losses faster and recover much sooner. We will also be more optimistic and better prepared for our next investment.
So the message this week is that we need to reframe bad financial experiences and move on to recovery rather than keep licking our wounds. By reframing the situation even if we didn’t jump on the investment bandwagon right away, at least our stress level would have been in check and I for one think we are all better off if we can reduce stress in our lives. The next time you have a negative financial experience, learn your lessons, reframe and move on. Taking action to correct rather than just protect is the only way to get ahead financially. Let your neocortex take over and move you into a better space. At the end of the day, true survival is really striking the right balance between our need for financial survival (governed by the reptilian brain, which is programmed to keep us safe) and our ability to recover when we make mistakes and incur losses (neocortex-our ability to think logically).