Whether it’s binging on a pint of Cherry Garcia, texting your ex or—like many who freak out when the stock market dips—withdrawing money at the worst possible time, we all succumb to temptations that go against our better judgment.
Even though we intellectually understand that it doesn’t make sense to sell low and buy high, why do so many of us still fall prey to this mistake? And more importantly, how can we avoid gut reactions like these?
Brain chemistry plays a big role when people make poor decisions in emotionally charged situations. “When we become excited or fearful, our prefrontal cortex, which is used for logical thinking, shuts off,” says Certified Financial Planner Brad Klontz, PsyD, founder of the Financial Psychology Institute. “The amygdala—the primal, animal part of our brain—takes over.” Basically, it’s fight or flight mode, and our frame of reference narrows to focus on immediate survival, rather than long-term wellbeing.
To counteract this tendency, put a barrier between any harmful impulse and actually pulling the trigger, whether that means educating yourself on normal market cycles or engaging in a stress-relieving hobby. “An acute sense of panic doesn’t last long,” Klontz says. “Giving your amygdala a chance to calm down will allow the prefrontal cortex to re-engage and function properly.”
Our herding instincts can also subvert our good intentions. “This is another survival mechanism,” Klontz says. “When we see others around us panicking—including on the news—we also panic.”
If you’re prone to this behavior, mute the talking heads. “As long as you have a solid, diversified financial plan, it’s better not to watch the news in a fluctuating market,” Klontz says.
The frequency bias is a cognitive error that leads us to believe that the way things are now is how they’ll be forever. For example, “younger investors who’ve never experienced a downturn may assume that the market will always go up,” Klontz says.
To fight it, broaden your perspective. If you (or your parents) were investing through the 2008 crash, it’s worth looking at how stocks rebounded—and continued to climb—and reminding yourself that downturns are part of normal market cycles. “If you’re surprised, you’re likely to misread the situation as being an actual threat,” Klontz says.
It also helps to think about your holdings as three different buckets: one for stocks, bonds and cash. When stocks falter, remind yourself that’s simply part of your aggressive bucket. If you can sequester the loss to one specific area, it won’t seem as panic-inducing.