Economics and Impulse
Similarly, our rationality with respect to investment strategies becomes decidedly occluded as the assets in question grow in value. Burnham explains the phenomena on PBS as follows:
“As I put it on the NewsHour, your lizard brain is built to find and act on patterns. So the lizard brain, by its very nature, seeks to replicate things that have worked before. If you threw a spear a certain way and you got food, guess how you’re going to try to throw it the next time? The same way.
The same algorithm applies to stocks. The stock that you fall in love with has four up days in a row. It must be a good stock, right? There must be some reason it’s gone up four days in a row. People are excited about it. They buy it. You buy it. The buying drives it higher — a self-fulfilling prophecy.
And the same thing happens in reverse. A stock plummets; There must be something wrong with it. The lower it goes, the more you hate it and the faster you get rid of it. As a result, you sell it at the low. This process pushes us to buy high and sell low, exactly the opposite of what any investor knows is the right thing to do: buy low and sell high.”
History has proven the point. Over a recent 20 year period, while stocks increased at an average annual rate of of 9.8%, the typical equity fund investor received returns of just 3.8%, barely eclipsing the inflation rate of 2.6% over the same period. Why? Overreactions to the ebbs and tides of the market prompted buying and selling at the wrong time within the various investment cycles.
Stock Market Climb or Crash?
Of course, nobody knows the answer to that question, at least not in the short term. However, by their very nature, markets cannot continue upward forever, as the lizard brain phenomenon eventually drives prices up beyond sustainable levels. Former Federal Reserve Chairman once called it “irrational exuberance”, yet another instance of phraseology shifting the emphasis from the cognitive mind to more primitive impulses.
Whether it be lizard impulses or just plain irrationality at work, one thing is self-evident: human beings are just not conditioned to buy low and sell high. More’s the pity.
Burnham, Terrance. Ben Bernanke as Easter Bunny: Why the Fed Can’t Prevent the Coming Crash. (2013). PBS. Accessed on July 18, 2013.
Wilford, John Noble. Oldest Reptile Fossil Reported Found in Scotland. (1988). The New York Times. Accessed on July 18, 2013.
Investopedia. Irrational Exuberance. (2013). Accessed on July 18, 2013.
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