Our Human Nature

By Ben Dolan, CFP®

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I’ve been doing a bit of reading on the development of the teenage brain recently. With two 14-year-olds in the house, I’d like to better understand what’s behind the generally glazed-over eyes (which my wife and I have affectionately termed “the fog”) and the quick, emotional, often irrational response to many questions posed to them (we don’t have a good name for this yet!). According to the team at Stanford Children’s Health, there is a very big difference between how adults and teenagers process information. Adults process information with the prefrontal cortex, the brain’s rational part, while teens process information with the amygdala, the emotional part of the brain.

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The unfortunate truth about our human condition is, even after our frontal cortex is fully developed, humans are susceptible to making quick judgements that may or may not be in their best interest (just like teenagers). Wise investors understand this tendency and will use it to their advantage. In fact, one of the best investors in history, Charlie Munger, knew this tendency all too well, and wrote about it in the 2005 publication of Poor Charlie’s Almanac. 

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While there is much in his book about investing, his most insightful speech (the book is a group of speeches given by Charlie through the years) is “The Psychology of Human Misjudgment”, in which Charlie explicates the “doubt-avoidance tendency.” He notes: “The brain of man is programmed with a tendency to quickly remove doubt by reaching some decision. It is easy to see how evolution would make animals, over the eons, drift toward such quick elimination of doubt. After all, the one thing that is surely counterproductive for a prey animal that is threatened by a predator is to take a long time in deciding what to do” (pg 305). 

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Today, our doubt-avoidance tendency exists in a different form. While we’re no longer worried about the predator-prey dynamic, we still live in an environment which triggers quick decision-making for doubt-avoidance purposes. Charlie points out that the two main triggers of the doubt-avoidance tendency are 1) puzzlement and 2) stress. With these two triggers in mind, consider the lack of personal financial education provided by our schools (including higher education!), combined with the stress of our modern world (fueled, in many ways, by a toxic social media culture inconsistent with reality). 

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Warren Buffet, Charlie’s longtime business partner at Berkshire Hathaway, in The Essays of Warren Buffet by Lawrence Cunningham, aptly describes what happens to investors in this low education high stress world: “Owners of stock, however, too often let the capricious and often irrational behavior of their fellow owners cause them to behave irrationally as well. Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits-and worse yet, important to consider acting upon their comments” (pg 80).

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I try to discuss this tendency toward knee-jerk reactions to market movements often with my clients. While it may seem counterintuitive, the extreme fear most feel when markets fall dramatically is an opportunity for the prepared investor. Buffett explains: “tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.”

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Having a sound investment philosophy allows for a strategic plan when inevitable market turmoil comes. When market euphoria drives markets to irrational values, it’s time to rebalance the portfolio toward asset classes that have done less well and have more attractive valuations. When prices drop below values due to fear (e.g. 2008), it’s time to put cash to work while discounts are available.