Investors’ brains on investing

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Investors’ instincts can be a powerful force for survival. But when it comes to managing money, intuition isn’t always on their side.

Why is that? Because our intuition is driven by The Brain, which, unfortunately, is programmed in ways that can make it hard for us to make good – as in logical, consistent – financial decisions. For instance, our brains are hardwired to:

  • Flee danger
  • Remember highs and lows
  • Strongly prefer avoiding losses compared to acquiring gains

As a result, faced with extremely volatile markets, many investors make quick decisions  to move their money out of the markets or stop contributing to their retirement plans. When they do that, they’re not being irrational. They’re just being human.

But, these human reactions can have a long-term impact on investor portfolios: investors’ risk can jeopardize their ability to reach their financial goals. In the midst of the emotions that volatility can trigger, it can be hard to remember the basics of risk-reward trade-offs. It’s the stock market’s inherent risk that offers the possibility of financial rewards. Without that risk, there can be no reward: they’re two sides of a coin.

Sometimes it can help to remind investors that what matters most is not how they feel about investing, but rather how they can make use of the markets, in both volatile times and calmer times, to help accomplish one of their most important goals of all: not outliving their nest egg. Intuition has its place. But when it comes to our portfolios, intuition should be secondary to facts and fundamentals.

Editors’ note: A previous version of this post linked to a document that has since expired.

Strategic asset allocation and diversification do not assure profit or protect against loss in declining markets.

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