This post has my reflections from this wonderful article by James Montier: Emotion, Neuroscience and Investing-Investors as Dopamine Addicts.
We think we make decisions using logic. This is usually false. We usually make decisions using emotion. We cannot get rid of emotion as we need emotion to make decisions. However, if we use emotion alone and not logic we can easily end up making poor decisions that will cost us in the long run. This is unfortunately the human condition and knowing this is the first step in making the best out of this situation.
We think we think about the long-term. This is false. We are naturally hardwired to think about the short-term. We do not want to delay gratification and we find short-term gains very attractive. These short-term gains stimulate the emotional centres of the brain, releases dopamine and makes us feel confident, stimulated and generally good about ourselves.
We think we follow our own path. This is again false. We are naturally inclined to follow the herd. When we go against the herd, we feel a lot of pain, almost like physical pain. That is why it is so difficult to be a contrarian.
We think that this is true for others and that we have a lot of self-control and we can overcome this. This is yet again false. Self-control is a limited resource. The more we use it now, the less we have for the future and very often we just capitulate.
So, we make emotional decisions, think short-term, go with the herd and self-control alone is not enough to overcome these. Very bad news.
But there is some good news: the brain is plastic and can change. So we have to create habits that will help us change. In investing, I think some good habits may be to:
- Using dollar cost averaging.
- Having a proper investment plan and following it, no matter what.
- Regular rebalancing between the asset classes we own.
- The Coffee-Can Portfolio Approach.
These are all easy plans but the secret is in following them. That is what is difficult and that is why we often fail in investing as in many things in life.