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What is your investment perspective?

This website is devoted to understanding how our cognitive illusions affect us when we make decisions concerning money. We all view the world from our own unique frame of reference, and when our view causes analytical inaccuracies we call that a cognitive illusion or bias. Or and an old friend put it; our “stinkin’ thinkin’ is erroneous!

Today I want to show a few examples of how our perspective can change how we see our investments and maybe some errors we can guard against. Let me throw out a few examples.

  • First, an easy one: Every time a stock is traded, the buyer believes the stock will go up, but the seller does not. Different perspectives!
  • Imagine yesterday you bought stock XYZ for $20 per share, today you look up the share price and it is trading for $30 per share, and 50% gain in one day. How do you feel?
  • Another scenario: A month ago you bought XYZ for $40 per share, today it is $30 and you have lost 25% of your investment. How does that make you feel?
  • Scenario, Part III: Yesterday, you got fed up with your holdings in XYZ to do anything and you sold it all for $20 per share. Today the stock is going for $30. How do you feel?

In all of the cases above, XYZ is $30 per share but your feelings about that share price are completely different. The difference is your perspective based on your purchase or sale price.

The point I am trying to make is that the market does not know or care at what price we bought a particular investment. Our perspective, however, controls how we believe the market should go based on the price we paid. We have thoughts like: My investment is down, I just want to get back to even before I sell. OR This investment has doubled for me, so I want to buy more and do it again. This type of investment thinking has no correlation with where the investment will actually go from here.

Important Thought: The price you paid for an investment has absolutely no bearing on where it is going from here! The market for that particular investment is completely separated from your buy and sell decisions once you have acted to buy or sell.

If you want to manage your own investing, be it stocks, mutual funds, real estate or ostrich farms you need to analyze your holdings or prospective holdings on current market conditions. Once you have bought or sold something, that event is done and has no bearing for the future of your portfolio. I hope this information helps you with your personal investment analysis!

Change is hard because the brain is hard-wired

Here’s a quick way to improve your health, the planet, and your bank account: become a vegetarian.

Assuming you’re not one already, you hated that idea, didn’t you?

Vegetarianism is arguably more of a hot-button issue than some, but substitute any radical change (try “give up your electricity”) and chances are, you’ll hate it, even if it rationally makes sense.

Generally speaking, people don’t like change, even when they know it’s for the better. A habit takes weeks at the shortest to form or break, and habits are like behavioral rules of thumb, making it easier to live our lives; of course we don’t like it when we’re asked to do something different. Thus, change takes time. But it’s not just psychological barriers that make it hard to change our behavior; it’s also because physical paths for new change must be carved out in our brains.

The brain consists mainly of neurons (brain cells) which “talk” to other neurons using chemical signals called neurotransmitters. The junctions where neurotransmitters live are called synapses. Synapses are critical in brain function; how many there are, where they are, and what neurotransmitters they contain affect memory, learning, emotions, mood, alertness, and more. Memories are commonly thought to be recorded by strengthening or weakening particular synapses and adding extra ones in certain neuronal pathways. So if you’re used to, say, defining a meal as “meat and two sides,” then it’s going to take a while for the neurons to change the right pathways, altering synapses, in order for your brain to be able to define a meal as “grain or vegetable base with protein side” (or what have you).

This doesn’t mean it’s not worth doing, of course. The brain is a marvelously adaptable thing, and the fact that the adaptation takes time because of the physical changes needed doesn’t detract from that. So the next time you try to change your behavior–perhaps by giving up your daily Starbucks or your monthly salon visit, or biking to work instead of driving–and find it difficult, don’t give up. Your brain is in the process of changing its scaffolding for your behavior, and once it’s done, your new behaviors will be hardwired into you, just like the old ones.

Your investment decisions can have global effects

If you could choose only one, would you choose to (a) save a thousand people in a foreign country from dying in an earthquake, (b) save a hundred people in your home town (but that you don’t know) from dying in a plane crash, or (c) save your best friend from dying in a car accident?

Most people will answer (c), and will choose (b) over (a). (Up the ante by changing “your best friend” to “your child” and all but the most Vulcan-like among us will answer c.) You could call it egoism–the view that humans always act based on rational self-interest–or emotionally-motivated behavior or just plain selfishness; but given the choice, people almost always choose to do what benefits them, even at the detriment of other people, especially if those other people are distant strangers.

This is healthy human behavior; we value what we have and what we know, and we act to protect what we value. Rationally, however, if we assume that human life in general is valuable, we know that (a) is the most logical choice. Most of us don’t worry too much about this, since saving one’s best friend from death is pretty big, and after all, it’s just a hypothetical dilemma.

Now let’s talk about the food crisis. Chances are you’ve heard that food prices are rising and seen it for yourself. There are a number of factors causing the higher prices: increased demand, low reserves, the weak dollar, the high price of oil…and speculators. This Washington Times article describes how investors are putting money into futures markets for corn, wheat, and rice (among other things), which actually drives prices higher.

Speculators have always played a prominent role in commodities markets, but in the past year, they have literally overwhelmed them, causing a dramatic increase in trading volume, volatility and prices and disrupting many of the normal relationships between producers and end-users.

…As with the credit bubble before it, the explosion in commodities prices has its origins in a global savings glut and massive trade imbalances…The difference this time, however, is that even before it bursts, this bubble is causing economic discomfort for households and businesses around the world, and misery for hundreds of millions of hungry people who suddenly cannot afford a bowl of rice or scrap of meat.

Generally speaking, your financial decisions affect you, your family, and maybe a corporation’s profit margin or a stock broker’s bonus. But this is a new twist in financial decision making, where deciding to make some money could mean making a family just like yours–even if it’s on the other side of the world–go hungry.

If you could choose only one, would you choose to (a) feed a hundred starving people in India, (b) feed ten hungry people in your home town, or (c) make a little extra money off the stock market?

Choosing to invest in the stock market, even in the commodities market, won’t directly bring you to that choice, of course. But it’s true that thanks to our truly global economy, your financial decisions can now truly affect people in foreign countries. What would you choose?

Addictions and Money – Caffeine

We all know how the more extreme addictions can ruin lives. An addiction to gambling, hard drugs, alcohol, or anything similar can wipe out a person’s finances and ruin lives. Thankfully, most of us have an aversion to such extremes. However, that doesn’t mean that our less extreme choices can’t have their own bad effects.

Let’s start our look at the field of more innocent addictions with caffeine. When we go after the root of the demand for caffeine, it seems to be in the fact that we (as a society) frequently don’t get enough sleep. Caffeine is the solution to that. It helps us wake up and function in the morning, and provides what appears to be a solution to our tiredness.

This blind spot in our decision making is often supported by medical research coming out in support of caffeine offering some health benefits. However, we all demonstrate a very specific decision making bias when we look at these effects and not at the other impacts of caffeine.

First and foremost is the money factor. Many of us get our coffee from specialty coffee stores. At best you might get a coffee for $2-3, more likely it’s upwards of $5 for your coffee. For the sake of argument, let’s say a reasonable average dollar cost is $10/day. Multiply that by an average of 200 workdays per year (assuming you drink coffee only at work) and you get a minimum of about $2,000 spent on coffee in a single year, which is far from an insignificant sum!

However, as with any addiction, to free yourself from this, you need to look at the factors involved. First is the physical addiction. As mentioned before, we’re a society of people who are incredibly tired, so we turn to caffeine. However, as with any drug, caffeine drinkers build up a tolerance, requiring more and more to achieve the same results. As well, there are withdrawal symptoms. These can include headaches, irritability, difficulty concentrating and stomach aches (see more about this). The only real solution to this aspect is more sleep. Breaking caffeine addiction can be hard, but substituting it with a beverage such as water can result in some significant net health benefits. By getting more sleep, you reduce your need for caffeine and at the same time benefit in overall health.

 

Few people view caffeine addiction with the same horror that they view an addiction to hard drugs, but considering that it can cost you thousands of dollars a year and cause a variety of health problems, it’s far from innocent. Contemplate freeing yourself from your addiction to caffeine, your wallet will thank you.

Do you want status or money?

For the Brain, Cash Is Good, Status Is Better

The article linked above has some very interesting results of a pair of tests researching which parts of our brains are concerned with earning or losing money and our reputations. The unexpected, and interesting, results of the studies revealed humans process making money and increasing our social status in the same area of the brain!

The area of the brain called the striatum had previously been identified as the brain’s monetary reward center. These new studies show the striatum is also where we process social values. This means having a good reputation affects our thinking in the same way as earning money. The studies further revealed that improving our reputation has priority over earning money in the straitum. So the answer to the title question of this post is that our brain functions to prefer status over money!

I can think of several ways this effect shows up in our lives:

  • An improved job title will often satisfy us more than getting a raise. We want our reputation and job description to show our status in life and will forgo more money.
  • A smart employer will understand that an employee’s status and reputation may have higher priority than actual income (within reason!). Employers should make sure employees are recognized in a public way for there contributions.
  • This characteristic can be dangerous in our financial decision making. Are we electing to make or avoid a financial decision because of how we think it affects our reputation? Or how it will affect us financially? This can apply to many areas: buying a home, making an investment, choosing an advisor, and even making everyday purchases.
  • This information may explain why we will pay significantly more money for similar items because of the brand or store.

Now that you are aware that your brain process your reputation and earning money in the same brain region, try to be cognizant of your financial decisions. Are you making them to improve or maintain your status, or to improve your net worth?

Cutting costs doesn’t mean losing status

The New York Times recently ran an article on the many ways that Americans are finding to cut costs in the current price-of-living increase we’re facing.

Spending data and interviews around the country show that middle- and working-class consumers are starting to switch from name brands to cheaper alternatives, to eat in instead of dining out and to fly at unusual hours to shave dollars off airfares…Retail sales figures and consumer surveys confirm that Americans are strategically cutting corners, whether it is at the coffee house or the airport.

If you’ve been feeling the pinch of $3.60-a-gallon gas and milk, you’re not alone; it’s happening to everyone, and people are acting on it instead of pretending it’s not there. They’re pinching pennies, cutting back on luxuries, doing for themselves rather than purchasing convenience.

Discounting worries over the economy and such, this is fantastic news for our brains. Consider: we don’t have to spend money we don’t have to look better than our neighbors. In fact, if our neighbors are pinching pennies, we may not even have to spend the money we have. The social pressure is easing off (for the working- and middle-class at least) to have the newest, shiniest things, and since relative wealth is the key to happiness, we don’t have to work so hard and buy so much.

Aside from a slackening in subconscious tension that comes from being in a race for social status, being able to look better than others with less money is a positive pleasure for the brain. Two studies recently published in the scientific journal Neuron found that the brain processes monetary and social rewards similarly. Keeping up with the Joneses (among other factors) has kept us as a nation from saving as much money as we otherwise might; now, knowing that the Joneses are letting their manicured lawn go dormant and their fashionable clothes go out of style will give your brain a double charge.

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