Think or react? That is the choice we have every time we are confronted with gyrating stock markets as we are right now. Make no mistake, your success as an investor and future financial security absolutely depend on it.

Please take a quick look at the graphic (below) showing two regions of the human brain. The red one at the bottom is known as the limbic brain system. In this area are the earliest developed brain functions that most animals have. These include the fight or flight brain circuitry; emotions like fear, anger, and attraction; and the unconscious functions of the brain, like breathing, heartbeat, and other bodily controls.

The Human Brain
The Human Brain

Then there’s the frontal lobe, at the top front of the brain, which is the source of our logical and rational thinking. This part of the brain is much newer in terms of evolution, and is what separates us from the rest of the animal kingdom.

When we are faced with a traumatic, life or death situation, one person might react by fleeing in fear, while another somehow exhibits a cool, calm demeanor, and as a result is able to do something heroic to save the day.

In August, a lone terrorist boarded a train in France and began firing an automatic weapon into the crowded train. Many ducked down or fled the train car. But three Americans traveling on vacation made the snap decision to take him down despite the risk, and have been rewarded with the highest honors France has to offer.

Have you ever considered what causes such different reactions in people? It is all about the person’s ability to access their logical brain and think rationally in the face of fear.

When faced with stock market volatility, a person who was relying on his limbic brain would be experiencing feelings things like this: This stock market is going to be the death of me. It has gone on far too long. I’ve been losing money for months now. I’ve already lost tens of thousands of dollars. If this keeps up, I’m going to be broke. My entire retirement is going up in smoke before my eyes. I’ve got to put a stop to this. I just can’t take another 50% stock market decline. Why isn’t my advisor protecting me from this? What is he doing anyway? I’m paying them good money to lose money? I’m terrified and need to get out NOW.

Let me be clear, we ALL experience these feelings. If you’re having them, it doesn’t mean you’re unevolved. Quite the opposite – the ability to recognize you’re having these feelings suggests you are more evolved (sometimes called self-differentiated). The key is to acknowledge and sit with these feelings, but take action using logic.

Here’s how a person who is able to recognize she’s scared, but then act with her frontal lobe (logical brain) might think: This really stinks, but I know that stocks go through rocky periods that sometimes seem to last forever. I remember that stock market returns are very lumpy, and the markets don’t give a darn how I feel about it. It’s nothing personal. Neither my advisor nor anyone else knows which way the market will go in the short run, and I’m glad they are taking advantage of these drops by buying more stocks for me at temporarily bargain basement prices. Buy low, sell high, right? My job now is to check my emotions and try to think long term. The long term returns of the stock markets have always been stellar, and there is absolutely no reason to think this time will be any different. I can totally wait this out. I’ve been through this in the past. I also know that during periods that follow the rough periods, the markets often have much higher returns. I trust that my advisor knows what they are doing, and I’m glad they are able to take the emotionality that I am experiencing out of the equation. Better times have always followed the rough periods.

As we stand here today, you have the opportunity to be the hero of your own story. You have a choice which part of your brain are you going to allow to direct your choices and actions. It makes a tremendous difference. According to a recent annual Dalbar survey, the 20-year annualized S&P 500 return through 2014 was 9.85% while the 20-year annualized return for the average equity mutual fund investor was only 5.19%, a gap of 4.66%! Why such a dramatic difference?

The difference in return was a result of the average investor being unable to recognize and control his limbic brain, causing him to jump in and out of the market based on short term movements that cause fear. The performance gap makes a world of difference! Consider that with a $1,000,000 starting investment, the total value of an investment in the S&P 500 after twenty years was $6.5 million, versus $2.7 million for the average investor. That’s nearly $4 million less for the investor who lets his emotional limbic brain rule his actions.

This is great in theory, but what if you’re still feeling stuck? Sometimes hard data can help.

Here is some real data to help you access your logical brain. Stock returns are VERY lumpy, and simply will never fit into our own preconceived views of what they should be. This is why they return much more than savings accounts – you’re being paid to weather the storm. Look at the returns of four different asset classes over the last seven years: the S&P 500, U.S. small stocks, emerging markets stocks, and large international stocks.

Stock Market Returns
Stock Market Returns

You might look at the last seven years of emerging markets stock returns (-1.0%) for example and say, “Why on earth would I invest in those dogs?” Well, because the long term average annual returns (including those seven bad years) was 19.8% per year. That’s eight percent per year more than the S&P 500. What’s more, since those have done so poorly in recent years, the odds favor them being among the highest returners over the next seven years.

Please also see this great chart called, Markets Have Rewarded Discipline. It shows many of the ‘bad’ things that have been occurring since 1970 that would cause a limbic brain user to flee the markets. Yet, if you lived under a rock, never knew about any of that news, and never changed your investment, a $1 million investment in the S&P 500 made in 1970 would have grown to $45 million today. Furthermore, as we’ve shown above it would have been substantially more if you also had small U.S., international, and emerging markets stocks in the mix.

We have 100% confidence in the financial markets over the long term. When I started in the advisory business 30 years ago this month, the Dow Jones Industrial Average was at 1,500, and all I heard back then was people saying, “The market is too high.” This included many pundits. Today, thirty years later, the Dow is over 16,000. That is a massive return by any measure, more than 1,000% higher. And of course, we still hear the chorus crying that the market is too high.

Just doing the simple math, I can, with a very straight face, say that if stocks continue their long-term average returns, the Dow should be sitting somewhere around 450,000 in 30 more years. I have no idea which direction the next 1,000, 2,000 or even 5,000 point move is going to be, nor frankly, should you or I really have to care, because it doesn’t matter in the long run. The long run is about as reassuring as anything I can imagine.

I hope this has helped you look at the investment world from a perspective you might not have considered before. By far, the hardest part of investing is controlling our limbic brains, relying more on our logical brains, and having patience. We have science and all the past recorded history of the capital markets to demonstrate that emotions and irrational feelings are no substitute for a well-thought out and reasoned investment approach. And that is exactly what we are doing for you.

So by all means, acknowledge your feelings. Call us to vent or come in to look at some reminders of why you’re sticking it out. We’re always here and love to hear from you.

 

Calling all neighbors in the Alamo, CA area and beyond! You work hard for your money, and now we want to help make it work for you. At Del Monte Group, we offer out-of-the-box wealth management planning that is clear and actionable at every step. If this sounds like the type of financial support you need, schedule an appointment to meet with Richard or Angela today. Visit APlaceOfPossibility.com/Calendar to get your meeting on the books. Need more help or have another question? Feel free to contact our team by calling 925.736.6410 or sending an email to Info@APlaceOfPossibility.com.

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