The impact of market volatility on our ‘lizard brains’ and how to deal with it

While the current market volatility isn’t my first ‘rodeo’ as a Wealth Adviser (I still bare the scars of the 2008 financial crisis), these types of actions by clients still have an impact on me.

As Josh Brown, CEO of Ritholtz Wealth Management says. “If you're going to be a financial adviser to investors and you're going to be worth anything to those investors, you have to have an investment philosophy that's long-term in nature and that is built to endure market events, economic crises, et cetera. You have to get people to believe in what they're invested in if you expect them to hold on to that portfolio through market volatility. If their relationship with their investments is casual and not spiritually and emotionally meaningful, then it's easy for them to discard those investments the minute the sledding gets tough...”

In these types of situations, however, we do have to recognise that we are fighting our ‘lizard brain’, the oldest part of the brain responsible for primitive survival instincts such as aggression and fear. The client’s flight or ‘action bias’ kicked in and he instructed the sale of his entire investment portfolio.

‘Action bias’ is a behavioural finance concept where we all prefer to do something at times of stress and uncertainty rather than doing nothing. 

A great example of this can be seen in football games. Imagine you are the goalkeeper facing a penalty kick. What do you do? Dive right? Dive left? Stand still?

A 2007 study looking at how goalkeepers react in the face of a penalty kick found an ‘action bias’. They jump to the left or to the right an overwhelming 94% of the time – meaning they stay in the middle only 6% of the time. In comparison, the shot went towards the centre 29% of the time.

The key here is that the goalkeeper is motivated by the fear of regret rather than the fear of failure.

To have dived and failed feels better than standing still and failing. Diving isn't reducing the potential for actual loss (i.e., the goal is scored) but does reduce the emotional loss to the goalkeeper.

Thoughts to help you through a volatile market

At times like these, investors will do well to remind themselves that such market behaviour is part and parcel of investing in stocks and that the ability to take advantage of the opportunities which present themselves in times of uncertainty is what typically generates superior long-term returns from equities.