Are you investing like a caveman?
Our brains have developed considerably since early primates diverged from other mammals about 85 million years ago. However, increasingly, behavioural psychology studies are showing us how one part of our grey matter has not changed: our ‘lizard brain’.
The lizard brain, or the limbic system (the thing keeping a lizard’s mind ticking), was used by early humans as a primitive ‘fight or flight’ response. It was also a mechanism for weighing up feeding and procreation options.
Fast forward several million decades, and it has been identified this prehistoric part of our brain is now central to the processing of our memory, decision-making, and emotional reactions. Increasingly behavioural science is examining how controlling your lizard brain can have a profound effect on the way we solve complex problems, from finding a life partner to making better investment decisions.
The lizard brain enjoys the short-term game. It prefers immediate and quick-fix solutions. It is more fearful of loss than hopeful of gain. This is great for low-value decisions like crossing the road or choosing a hamburger. But engage your lizard brain with anything more complex, and there can be disastrous consequences.
The problem is the framework of the lizard brain emphasizes a narrow spectrum of information; obsessing about previous data while discounting future uncertain indicators. This ancient structure exerts powerful and often unconscious influences on behaviour; and, in the world of investments, it may explain why experienced investors buy at irrationally high prices and sell at irrationally low ones. Lizard brain thinking may also lurk at the bottom of financial catastrophes.
Behavioural psychologists talk about the lizard brain being essentially resistance. It is that little voice in the back of your head, the one telling you something will never work; the one which worries people will laugh at you. And when under pressure, with the stakes raised and people watching, rather than rationally appraising all the options, the lizard brain instinctively strikes. Behavioural research shows consistently employing an instinctive response in complex, high stake decisions has a negative outcome.
Tripping the lizard switch
We see process as key to tripping the lizard switch. While over the short term, some managers may perform due to instinct, it is those managers who apply a rigorous long-term process and don’t overreact to stimulus that consistently deliver on set goals and objectives.
The lizard brain is also a problem for the wider financial health of the world. It has deep implications for the health of the UK’s savings. For example, our hunter-gatherer ancestors chose instinctively to consume food rather than stash it for fear of it being stolen, or it perishing. That ‘consume now, worry later’ mentality is still, to a large extent, hardwired into our brains. This has dangerous consequences for UK pensions as we see the shift in responsibility of saving moving away from companies, who previously provided generous final salary pensions, towards individual savers who are not saving enough. In the new era of defined contribution, young savers will have to override the caveman impulse to consume / spend now, in favour of a rational process-driven approach to ISA investing and pensions contribution to ensure a healthy financial future. It is only this kind of thinking that will help to imbue a real culture of saving.
The challenge for the saving and investment community is the world has changed far faster than our primate lizard brains. So, to avoid investing like cavemen we need to start silencing our inner lizard and taking more process-driven and rational approach to our financial futures. The time to start thinking differently about this problem is now.
Mitesh Sheth is director of strategy at Redington.