Investing for Entrepreneurs: Navigating Emotional Mindfields
Investing for Entrepreneurs: Navigating Emotional Mindfields
Though hope is helpful in most areas of life because it gives us optimism and a reason to live, in the investment arena, it can quickly drive our portfolio in negative territory. Our desire for excessive investment returns can overshadow realistic probability. This means we either don’t know what is reasonable to expect, or we overlook it because hope prevails over realism. As an example, investors fall prey to a ‘pump and dump’ scheme by responding to Internet solicitations from an unknown person to buy a low cost stock that is reportedly poised to increase in value. Then, the E-mail sender waits until his innocent prey takes the bait and “pumps” up the price of the stock. This is the queue for him to sell and make a profit because of artificially inflated stock price. His naïve and unwary Internet victims are left in the lurch with a stock that falls when it becomes apparent that the news about the projected gain was untrue. In the words of Warren Buffet, “It is optimism that is the enemy of the rational buyer.”
There are two corollaries to “Optimism over realism.” One is overconfidence. This is because it ultimately leads to losses because an overconfident investor thinks he can beat the market because he assumes he can pick stocks that are winners. Therefore, he overtrades. Barber and Odean showed that men overall make less in the stock market than women because they buy and sell stock more often. These researchers attributed their findings to overconfidence, characteristically found more in men than women. Warren Buffet says, “Much
success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.”
Another associated consequence of “Optimism over realism” is what Bailard, Biehl and Kaiser Communications Group called the “celebrity.” These are people who are very successful and busy. They don’t have time to do investment research. The natural conclusion is that they are lacking well thought out ideas about how to handle their own investments. Therefore, they latch on to whatever ‘hot’ topic they are exposed to through the media or their contacts. They often take hot tips and act on them. They optimistically think that these unfiltered ideas can help them financially. Doctors and entertainment personalities were found to be in this category. These celebrity investors are especially vulnerable to “the golden tongue” salesman who is skillful at making projected benefits appealing, though they never materialize. Some insurance salesman, stockbrokers, and financial advisors fall into this devious group that can bring financial ruin to a celebrity client
Another mind-field, but one that can be deadly, is excessive risk taking. Individuals who are prone to risk taking behavior are stimulating their pleasure center, the nucleus accumbens, when they make perilous financial choices. Activation in the nucleus accumbens is associated with a positive anticipatory affective state, which makes the investor feel good. This is caused by dopamine release.
Geneticists Kenneth Blum and David Cummings label this drive for excessive risk taking "the reward deficiency syndrome." People with this condition are unable to get sufficient satisfaction from the usual rewards in life and need to up the ante. The geneticists have identified a variation of a normal gene that prevents dopamine from binding to cells in the reward pathway. Therefore, the satisfaction usually felt with the release of dopamine is diminished and must constantly be reinforced. One way to do this is to constantly take risk. Although the studies to date have focused on addictive behavior, there may be a variation of the condition that contributes to financial risk-taking or other varieties of the same danger seeking personality such as hazardous sports. The problem for the risk prone investor is that risky behavior rarely earns better investment returns over time. Usually, it simply means that more risk is taken for the same or often less return. As Warren Buffet says, “An investor needs to do very few things right as long as he avoids big mistakes.”
The positive news here is that recognizing one or more of these mind-fields in our own behavior mean we can deal with it proactively to produce better investing results in the future. In investing, as in every other area of life, Sir Frances Bacon’s quote is as good today as it was in 1597, “Knowledge is power.” This aptly applies to understanding our own frailties in the stock market as well as strengths.
First published in the Indianapolis Business Journal: Summer, 2008
Investing for Entrepreneurs Navigating Emotional Mindfields - To learn more about this author, visit Shirley Mueller's Website.
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This is a dizzy market, maybe even ill, but it isn't terminal. Learning how to manage one's own emotions while investing is an important part of success. And, the most crucial factor here is practicing ‘realism over optimism,’ instead of the reverse.
Though hope is helpful in most areas of life because it gives us optimism and a reason to live, in the investment arena, it can quickly drive our portfolio in negative territory. Our desire for excessive investment returns can overshadow realistic probability. This means we either don’t know what is reasonable to expect, or we overlook it because hope prevails over realism. As an example, investors fall prey to a ‘pump and dump’ scheme by responding to Internet solicitations from an unknown person to buy a low cost stock that is reportedly poised to increase in value. Then, the E-mail sender waits until his innocent prey takes the bait and “pumps” up the price of the stock. This is the queue for him to sell and make a profit because of artificially inflated stock price. His naïve and unwary Internet victims are left in the lurch with a stock that falls when it becomes apparent that the news about the projected gain was untrue. In the words of Warren Buffet, “It is optimism that is the enemy of the rational buyer.”
There are two corollaries to “Optimism over realism.” One is overconfidence. This is because it ultimately leads to losses because an overconfident investor thinks he can beat the market because he assumes he can pick stocks that are winners. Therefore, he overtrades. Barber and Odean showed that men overall make less in the stock market than women because they buy and sell stock more often. These researchers attributed their findings to overconfidence, characteristically found more in men than women. Warren Buffet says, “Much
success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell.”
Another associated consequence of “Optimism over realism” is what Bailard, Biehl and Kaiser Communications Group called the “celebrity.” These are people who are very successful and busy. They don’t have time to do investment research. The natural conclusion is that they are lacking well thought out ideas about how to handle their own investments. Therefore, they latch on to whatever ‘hot’ topic they are exposed to through the media or their contacts. They often take hot tips and act on them. They optimistically think that these unfiltered ideas can help them financially. Doctors and entertainment personalities were found to be in this category. These celebrity investors are especially vulnerable to “the golden tongue” salesman who is skillful at making projected benefits appealing, though they never materialize. Some insurance salesman, stockbrokers, and financial advisors fall into this devious group that can bring financial ruin to a celebrity client
Another mind-field, but one that can be deadly, is excessive risk taking. Individuals who are prone to risk taking behavior are stimulating their pleasure center, the nucleus accumbens, when they make perilous financial choices. Activation in the nucleus accumbens is associated with a positive anticipatory affective state, which makes the investor feel good. This is caused by dopamine release.
Geneticists Kenneth Blum and David Cummings label this drive for excessive risk taking "the reward deficiency syndrome." People with this condition are unable to get sufficient satisfaction from the usual rewards in life and need to up the ante. The geneticists have identified a variation of a normal gene that prevents dopamine from binding to cells in the reward pathway. Therefore, the satisfaction usually felt with the release of dopamine is diminished and must constantly be reinforced. One way to do this is to constantly take risk. Although the studies to date have focused on addictive behavior, there may be a variation of the condition that contributes to financial risk-taking or other varieties of the same danger seeking personality such as hazardous sports. The problem for the risk prone investor is that risky behavior rarely earns better investment returns over time. Usually, it simply means that more risk is taken for the same or often less return. As Warren Buffet says, “An investor needs to do very few things right as long as he avoids big mistakes.”
The positive news here is that recognizing one or more of these mind-fields in our own behavior mean we can deal with it proactively to produce better investing results in the future. In investing, as in every other area of life, Sir Frances Bacon’s quote is as good today as it was in 1597, “Knowledge is power.” This aptly applies to understanding our own frailties in the stock market as well as strengths.
First published in the Indianapolis Business Journal: Summer, 2008
Investing for Entrepreneurs Navigating Emotional Mindfields - To learn more about this author, visit Shirley Mueller's Website.
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