You’re standing in line at the gas station, and you notice the guy in front of you browsing a display of lottery tickets. His eyes are bouncing lackadaisically from one ticket to the other until, all of a sudden, they stop. His eyes grow wide with delight and, almost as if a string is pulling it, his hand gestures forcefully toward the ticket. “This one!” He exclaims to the clerk in front of him.
“What’s so special about this lottery ticket?” You wonder. You glance at the price tag: $20. The ticket is more expensive than all the others in the display. Why would the guy want that ticket? That’s when you notice the sign. The current prize for this ticket, if it should be a winner, is one billion dollars!
I’m going to let you in on a little secret. There’s a conspiracy going on that affects each and every one of us. There’s something implanted in our brains that controls our impulses and causes us to sometimes make what turn out to be very poor decisions. And, who is responsible for this massive mind-control scheme? Well, our brains are responsible. That’s right, our very own brains are conspiring against us.
Your brain craves the big score. Whether it’s a high value lottery ticket, a deep-fried triple bacon cheeseburger, or a getaway to a tropical paradise, we tend to want it all and we tend to want it now. We want instant gratification, and our rationality tends to go out the window when it is held tantalizingly before us. It is for this very same reason that investors tend to bet on their favorite stocks.
Stock picking — picking specific stocks based on some predetermined criteria as opposed to sticking with indexes — feeds our primal desire for excitement. Merely imagining that a certain stock or group of stocks will bring massive returns causes dopamine to be released in the investor’s brain. That’s where the euphoric feeling of excitement comes from, similar to the high people get from taking drugs or — as mentioned before buying lottery tickets.
But stock picking can become catastrophic for investors. When we favor the stocks we see performing very well or the stocks for which we have some sort of affinity, we begin to ignore the warning signs that we would otherwise notice when those stocks or their industries begin to weaken. Remember, no one stock or even group of stocks is smarter than the entire market.
Our brains are set up to trick us in so many ways and, rather than subduing those foibles, stock picking indulges them. When we do engage in stock picking, another psychological trick — confirmation bias — makes our situation even worse. We begin to explain away the poor performance of the stocks and exaggerate the times when the stocks perform well. In other words, we fall in love with the stocks and feel as if we need to defend them.
Stock picking almost always leads investors down the wrong path. If you want to be a great investor, stick with indexes. Need help understanding just what that means and how you can use indexes to your advantage? Feel free to reach out to us for a free consultation. We would love to help you become the great investor we know you can be.