A friend passed this on to me this morning… I think it’s an excellent article. The only thing I wish he’d mentioned was the importance of doing your research before buying an investment.
(Money Magazine) — Slow and steady wins the race, but a bird in the hand is worth two in the bush. Those dueling proverbs sum up the investing mind.
When you imagine choosing between making a quick buck or growing rich later, you know the right answer: Be patient and hold out for the bigger gain. But as soon as you face a real rather than an imaginary choice, the fast money seems irresistible.
New discoveries in neuroscience labs are helping to explain why it’s so hard to resist the allure of instant gratification. It turns out that your brain is much more aroused by $1 today than by $1 tomorrow. And $1 six months from now barely registers.
Only the promise of a much bigger reward later can fire up your brain the way an immediate score does. No wonder it’s hard to save instead of spend and, when you do save, to think long term; the average holding period for a stock, among individual and professional investors alike, is just over 11 months.
And the temptation to buy dotcom stocks in 1999, energy stocks in 2005, real estate in 2006, emerging markets in 2007 or gold right now — what’s hot when it’s hot — is overpowering for many people, no matter how often they’ve been burned before.
A sip now or a slurp later?
Recent experiments conducted independently by three teams of researchers at leading universities have focused on the battle in the brain between now and later.
Tracking people’s choices and their brain activity, one group tested whether college kids would rather have a sip of fruit juice soon or a slurp later. They also tracked how folks decided between Amazon.com gift certificates redeemable the same day for a small amount and those redeemable up to four weeks later for a larger amount.
A second team offered people the choice between $20 immediately and an array of alternatives ranging from $20.25 six hours later to $110 six months later. And a third group measured how individuals responded to the choice between various dollar amounts today and an extra 5 percent to 30 percent up to six months later.
“When our emotions are charged, we have a hard time waiting for a reward,” says Carnegie Mellon University’s George Loewenstein, one of the first study’s authors. Even the chance of getting a slightly bigger reward tomorrow doesn’t have the same stimulating effect on your brain as a gain today does.
It’s all downhill from there. A gain the day after tomorrow carries even less of an emotional kick, and so on. In fact, to the typical person, $20 now is better than $23 three weeks from now, $40 three months from now or $47 six months from now, according to the second study, led by a pair of New York University researchers.
In short, for your brain to be willing to wait a mere three weeks for a higher payout, that $20 would have to grow at an annualized rate of roughly 4,800 percent.
Rational? Hardly. But evolutionwise, the response makes sense. In our hunter-gatherer days we often faced scarcity. And when we’re really hungry, a future feast has to be huge to justify choosing it over eating now.
So are we moderns doomed to save and invest like cavemen? Not necessarily. Knowing that you operate in what NYU’s Paul Glimcher calls “as soon as possible” mode is the first step to making better financial decisions. Willpower and good intentions, though, aren’t enough. You need help. Here’s what to do:
Lock in for later. Saving now is harder than planning to save later. So commit yourself to doing the right thing a year from today. Want to raise your 401(k) contribution? Use calendar software to mark the distant date when you’ll take action — and send an e-mail to a small group of friends now and on that day reminding them that you have committed.
Don’t take your lumps. When you change jobs, it’s tempting to take the money in your old 401(k) as a lump sum instead of rolling it into a new plan or an IRA, especially if you’re decades from retirement. So whenever you’re starting a job hunt, pledge in writing to a friend that you will roll over the retirement account.
Likewise, if you are older and are fortunate enough to have built up a sizable pension benefit, pledge that instead of taking a lump sum when you’re eligible, you will string your pension out over many years as an annuity. Have that commitment witnessed by friends or family members who are younger than you are so they will likely be around when you put away the work shoes.
Similarly, when you’re investing your savings, you need to resist the temptation to simply go for whatever looks as if it will provide a quick return. Take these steps:
Answer two big questions. Why — other than a rising stock price — should I invest in this business? Do I have any reason to think that I know more about this company than whoever sells me the stock?
Sleep on it. If putting money into a hot mutual fund is really a good idea, it’ll still be one tomorrow. Waiting until the next morning won’t cost you much profit, but letting your brain’s anticipation circuitry cool down overnight could save you from an ill-timed bet. And you’ll be richer for your patience.