The Investment Scientist

Stocks On Sales

Posted on: June 6, 2012

This is a client communication letter I wrote on June 1st. One week after i wrote this, the market closed out its best week in 2012.

Investment and Amygdala

Don’t Use Amygdala to Make Investment Decisions

As I am writing this, the markets are falling like a rock. The Dow has entered negative territory for the first time this year; Nasdaq, which was up 20% a mere two months ago, is up only 5% for the year. The S&P 500 has lost close to 10% of its value since its April 1 peak.

I wrote the above paragraph using typical financial press lingo. This type of language has the tendency to cause amygdala hijack.

The amygdala is a part of our brain that processes threats. When we perceive a threat, the amygdala takes over the whole brain. fMRI scans show that blood supplies are literally commandeered from other parts of the brain for the amygdale. The amygdala is not sophisticated; it only knows three responses: fight, flight, or freeze.

Amygdala hijack was extremely crucial to our species’ survival. When our hunter/gatherer forebears were accosted by a fierce lion, amygdala hijack caused them to stop marveling at the lion’s mane and instead primed their bodies for survival: either fight the lion, flee from the lion, or freeze so the lion wouldn’t notice.

Neurological research has shown that our reaction to the stock market falling is very similar to our ancestor’s reaction to the approaching lion. This is unfortunate, since falling stocks won’t eat us alive, but not thinking clearly could lead us to make bad financial decisions.

I believe there is a need to use different lingo to describe falling markets. Here is my attempt to rewrite the first paragraph:

As I am writing this, stocks are on sales. For the first time this year, the Dow is cheaper than at the beginning of the year. The Nasdaq, though up about 5% year to date, is nevertheless 15% cheaper than its April 1 peak. The discount on the S&P 500 is not as big, but still close to 10%.

How do you feel now? Do you see the event more as an opportunity than a threat? And indeed it is an opportunity. The odds of markets falling more than 10% in a given year is almost 100%. Just like a supermarket has sales periodically, so does the stock market. Why not use this opportunity to stock up shares on the cheap.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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