The human mind is a beautiful thing. Every day, we make hundreds of choices and our mind can still avoid exhaustion. We make decisions about things like when to wake up, what to eat, when to sneeze, what to wear, and which foot to begin walking with. Sometimes we make much bigger decisions, like choosing a mate, and whether to pursue a business opportunity. At the end of the day, our lives are really a giant collection of decisions of all types and importance. So how does our mind keep up with the enormity of decisions?
Our brains can be divided into two functional parts, the intuitive mind and the reflective mind. The intuitive mind sits at the bottom and back of the brain, closest to the spinal cord. Sometimes referred to as the reflexive mind, this part of our brain simply reacts with very quick decisions. For example, if our hand was being burnt by a hot stove, our reflexes would react quickly to remove our hand, without methodically calculating all of the pros and cons first. This function also helps with the overwhelming number of insignificant decisions we make on a daily basis.
Only when the intuitive mind can’t reach an immediate decision does the reflective mind get involved. This part of our mind is analytical, carefully weighing all the options and their probable consequences. This part of our brain will take longer to reach a decision, but it will most likely be a better decision.
The problem for investors lies when they react to market conditions using mental shortcuts, rather than engaging the reflective mind for a careful analysis. This is often the case when markets and account values fall. Losing money sets off an alarm that is just as mentally painful as when our hand is being burnt by a hot stove. When mental pain is high, it is easy to instinctively make a drastic change, rather than calmly take into consideration the long-term plan, asset allocation, diversification, and long-term history.
For many decisions, following your gut can be an efficient and effective process, but for investing, it often leads to a poor decision. Usually the best investment path is the run away from your gut.