Question: Given the latest political, fiscal, monetary, global as well as domestic economic developments, how should one invest in 2018?—asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph and Facebook.
Answer: Experts say that we should always invest with the risk-return tradeoff in mind. And the cardinal rule, postulate and unbreakable law in investing is that high risk comes with high return.
Yet, even with the risk-return tradeoff in mind, investing can still be so very stressful. Apparently, that is because we still invest with our emotions. Early in the 20th century, a guy by the name of Jesse Livermore already warned that knowing the ABCs of investing was not enough and that we would need to also avoid the FGHIs or fear, greed hope and ignorance.
Emotions are what gum up the works when it comes to investing. Take the case of the disposition effect. When a newbie invests in stocks, he will immediately sell when he starts to make money for fear that he might lose what he has already earned. This is no different from a newbie in a casino who starts to cash in as soon as he makes some winnings.
But when a newbie in investing loses, he will continue to hold on to his stocks and wait for a rebound because he fears realizing a loss. The same is true with the newbie in a casino who keeps on betting until he starts to win or lose all of his money.
Does this mean that newbie investors treat investing in the stock market as gambling? That is part of the reason. But the larger reason is the emotion of fear.
Our brain has a three-part emotion regulation system, components of which are called the safeness-caring, drive and threat subsystems. Of the three, the threat subsystem is the most powerful. It lies in the amygdala and operates on adrenaline and cortisol. When this subsystem picks up threats, typically through our five senses, it creates powerful bursts of emotions like anxiety, anger and disgust that motivate us to action. The system has been there since the time of the caveman and is essential for survival.
When a dog suddenly barks at us, our amygdala will sense a threat and stimulate our hypothalamus to trigger a fight or flight response. The fight-flight response will increase our heart rate while slowing down our digestion so that blood can be pumped to our larger limbs to power our escape. Our pupils will dilate to let in more light so that we can see the threat or the escape route better. And a surge of adrenaline gives our body an instant burst of strength to either fight the dog head on or run away.
Unfortunately, it is the overuse of the threat subsystem that leads us to irrational decisions and actions. Focusing too much on risk will make us miss out on the investment opportunities out there that could effectively help us meet future needs in a more affordable way.
The threat system needs to be balanced with the other two
subsystems of safeness-caring and drive. Let’s continue discussing the two other systems in the next and concluding installment of this article. Until then, try not being too fearful.
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