Taming the Lizard Brain: Expert Investment Advice

Interview with Ben Kumar Head of Equity Strategy at 7IM

Article ⸻

Taming the Lizard Brain: Expert Investment Advice

Behavioural Finance  Interview with Ben Kumar Head of Equity Strategy at 7IM on ‘Taming the Lizard’

April 28, 2023

The term behavioural finance is the study of how psychological influences can affect your decision making on savings and investments. This is a really timely subject as we face uncertainty over tough economic conditions with global financial markets and central banks in a current state of great flux.

In this blog we discover more about behavioural finance with Ben, who specialises in this area.

 

We began by asking Ben to expand on the concept and what we, as individuals, can do to help reach rational decisions when we’re thinking of investing or remaining invested.

Ben: ‘If you go back to the middle of the last century, after the Second World War, interest in economics really got going and there was an excitement about the fact that maybe you could describe the whole behaviour of human society when it came to money and finance, using models that could tell you what to do and whether to raise interest rates or cut them and so on. For several decades economists built more and more complicated models that tried to generalise what the whole of human society was going to do. At the same time psychologists were looking at why people reacted differently to certain things or events which meant they struggled or succeeded.

In the 1970s, a couple of economists, Richard Thaler being foremost among them, started noticing that their clever models with all the maths underpinning them weren’t followed by the people. These models that were meant to predict behaviour at a large scale were actually being disobeyed by quite a lot of people, quite a lot of the time. They were behaving irrationally from an economics point of view. Some of the psychologists, Daniel Kahneman and Amos Tversky, two Israeli psychologists, started thinking, well, hang on, we’ve noticed a lot of patterns of behaviour in our individual people that maybe we could scale up to be a general rule of thumb. They concluded that people are people, they’re not computers, they’re not following numbers, they’re not following formulas. We all have emotions, we have views, we have thoughts and most importantly, we have biology. We have millennia, hundreds of thousands of years of biology, which to an extent dictates our behaviour in a way that we sometimes don’t even think about.

I can’t remember who it was, but someone described humans as a rational being, but it’s wrapped around the brain of a monkey, which is wrapped around the brain of a rat, which is wrapped around the brain of a lizard. And all of those other various animals, in evolutionary terms, have their say. We came up with a simplified version of this a few years ago, when thinking of the financial markets in particular, which we just call the lizard and the lizard brain. Lots of the time you make decisions really consciously and in a really aware way, but other times you don’t. There can be a time when you’re just so hungry you pick the first thing that you see in the fridge and there are times when you’re so tired you make a decision that you’d never have made if you were thinking clearly about it. There are times when you might sit down in a restaurant and you know exactly what you want to order, but then when someone else orders something different, or when a different sizzling meal is brought past you, you change your mind. Despite the fact that beforehand you’d have said, “Absolutely, I’m having the steak”, the fajitas go past, and you think “I want them”.

A kind of simplification for this is the idea of the lizard and there’s some biology to back it up. The bit of your brain that sits on top of the spine, basically, is called the basal ganglia and it’s found in almost all creatures, including lizards. It’s responsible for primarily thinking as quick as possible and reacting as quick as possible to situations. So, when there’s danger, the basal ganglia kicks into gear and starts prompting a response in your body before the rational part of you can even engage.

The example I always use is when you’re crossing a road, what you don’t want to do if there’s a car coming too fast towards you, is try and calculate how fast the car is coming, how fast you’re walking, the angle of interception, whether the colour of the car is relevant, you don’t want to do that. You need something to pull you out of the way as quickly as possible. And that thing in your brain is the lizard. It’s fight or flight and survival mode.

There’s a fascinating bit of research that says that every time you have to think about a decision, it costs you energy to run your brain. In the same way it costs energy or electricity to run a supercomputer. So, every decision you have to think hard about costs you energy. This bit of research found that on average people make something like 220 decisions a day, or are faced with 220 choices a day, just on what they’re going to eat. Even just making 220 decisions a day on food would be exhausting, so we let the lizard take over.

If you apply the lizard mentality to finance, you start to see what the problem is because the lizard never likes to do nothing. If you present it with a choice it will tend towards action. If you think about how a lizard lives its life it tends to lie in the desert, essentially napping and getting its body temperature up and then if something changes, it has to respond, whether it’s a predator coming for it or whether it’s some prey that it needs to go and eat. Every time there’s stimulus for a lizard, it needs to respond, – go and eat or run away. When you think about how our modern financial world is, there’s always something which could warrant a response, for example, markets have fallen, or a stock is doing particularly badly, or interest rates have risen or interest rates have fallen.

We’re bombarded with news, mostly negative, so what does that mean for my portfolio? What does that mean for investing and so on? Because this lizard brain has a bias to action, it will always think you are in danger, so when you see that negative headline, the lizard brain is going to need to react and do something and your conscious, rational side of your brain isn’t prepared to step in every single time and even if it were, it’s slower than the lizard is to respond. So, you read a bad headline and you’ve got the reptile in the back of your brain screaming, “Something’s happening here, we need to take action” and you either need to engage your rational brain to calm it down, which costs you energy. If you’re tired at the end of the day you might not want to do that or you let the lizard, which has no idea about financial markets, long term investing, the value of shares or anything, make a decision, whatever that decision is going to be and it’s completely uninformed.

 

Is it fair to say we effectively have it built into us, biologically, that we look to take the safest route?

Ben: ‘Yes, absolutely. The lizard’s prime directive, if you like, is to avoid pain, so whatever format that pain takes, it will try and stop it happening in the immediate term. So, if you’re standing near a hot stove, the lizard is responsible for you pulling your hand away. If you’re outside, freezing cold, the lizard will be telling you to get inside quickly, so you don’t suffer and if your portfolio is losing money, it will say, why don’t we hold cash? Actually, what it will say is, why don’t we stop this pain? I never want to feel that pain again and that is exactly right. That loss aversion exists in almost every single human being. People that it doesn’t exist in, we tend to call sociopaths or psychopaths.

The idea really is that in general, for us to make a decision we need to see the gains be twice as much as the potential loss. So, the example, if I say, okay, I’m going to toss a coin and you must tell me if it’s going to land on heads or tails and if you get it wrong, you give me £50, how much do you need to win for you to think that it’s worth playing if you get it right? It’s probably going to be £100 rather than £51 otherwise it’s not worth taking the risk and because it hurts every time you lose.

They did some fantastic analysis of professional golfers and if you’re playing golf and you’re putting for a birdie, you’re putting for a win. If you’re putting for a par, you’re putting to avoid making a loss, to avoid going over par. They found through decades of data that golfers putted twice as accurately for a par, to avoid a loss, as they did to get a win.’

 

With so much information that is now conveyed through different platforms and media outlets, are we guilty of making decisions on the back of initial information rather than taking the time to consider all points? 

Ben: ‘Yes absolutely. It’s called ‘anchoring’ when you formulate your views on something based on the first bit of information you hear on that topic. Most news tends to be alarmist and somewhat negative and therefore your view of the world is going to be alarmist and a little bit negative, which means you’re going to have to fight really, really hard to overcome that.

The best thing to do when it comes to managing that information flow on investment portfolios is actually not to read anything financial at all, if possible, unless like me, I have to stay on top of what’s going on in the world. The best thing to do as a client is just to reduce the number of times you check your portfolio in a given period. The more often you check your portfolio, the more often you check the value of the FTSE 100 or whatever, the more disappointed you’re likely to be. Because when there’s negative news, the portfolio will drop in value. When there’s positive news, perhaps the portfolio or the FTSE 100 will rise. But as we just discussed earlier, you feel the losses way more than you feel the gains. I can’t remember the exact figure, but over the last 30 years, the global equity market on a daily basis has been up 54% of the time, and down 46% of the time. So, if you looked every day for the last 30 years, it would be the same as flipping a coin and the associated feeling you get with that. However, over that period, it’s gone up about 700% turning £10,000 into £80,000, so if you’d have just looked once at the start of the thirty years and once at the end, all you saw was your money increasing eight times. That’s guaranteed to make you feel good in a way that watching it daily just never does.’

 

What can happen if you let that the lizard get the better of you and go to cash to avoid the pain of a falling market?

Ben: ‘One of my favourite charts shows that if you’d missed the best 30 days in the FTSE 100 over the last 20 years for example, your overall return goes negative from being up about 5% or 6% a year on average. Most of those really big rally days come within a week or two weeks of the worst performing days, so the top ten best days are within a couple of weeks of the top ten worst days. It’s common to see that just after those top ten worst days your lizard is going to be feeling most terrified and most likely to sell and most likely to anchor on the bad news. That’s why selling after a fall is often, I think almost always, the worst thing that anyone can do because it increases the chance of missing those good days. The best recipe is stay invested as long as you can and acknowledge, accept, that over time the world gets better and our investments reflect that.’

 

Our thanks to Ben Kumar for his insight into ‘Taming the Lizard’.

Matt Rowe

Financial Planner
Piercefield Oliver