Don't Let Your Brain Bully You Into Taking On Too Much Risk

Many investors who have missed out on much or all of the bull market gains since 2009 are now rushing back into stocks, The Wall Street Journal’s Jason Zweig says. And, he says, they may be making a big mistake.

Zweig says that recent returns — good or bad — can cause investors to change their asset allocations in ways that may not be best for the long haul. Good returns can make you feel like you’re playing with “house money”, he says, while poor returns can make you want to catch up — both leading you to take extra risk that can come back to bite you.

There’s science behind those tendencies, says Zweig. “Recent gains or losses change how the human brain assesses risk, according to a study that will appear later this year in a well-regarded psychology publication, the Journal of Economic Behavior & Organization,” he says. “People were roughly 20% more likely to take a gamble after either a gain or loss than after a neutral outcome, the study shows. During the experience of profits and losses alike, several regions of the brain involved in emotion became more active, while activity dwindled in areas devoted to executive decision-making.”

Zweig offers some tips for how to deal with these tendencies, including what one psychologist calls “therapeutic reframing”. He also talks about the importance of slowly easing back into the market if you want to increase your equity exposure.