How to Avoid Emotional Investing

By David Pitt, AP Personal Finance Writer

CHICAGO (AP) — Buying and selling stocks at just the wrong time is costly. Yet millions of investors make bad deals every time there is a major market swing.

The recent market downturn is no exception. Investors pulled billions of dollars out of stocks as the markets fell, letting fear lead them to sell as stock prices bottomed.

Many also failed to act quickly enough when the stock market reversed course and surged 76 percent from March 2009 to mid-April of this year. As stocks rose, billions of dollars continued to pour into lower-yielding bond funds rather than stocks. Emotion kept investors from reinvesting and regaining some lost ground as stocks rose.

The reason behind this behavior is quite simple, says Terry Burnham, a former Harvard economist with degrees in economics, computer science and biophysics. He wrote the 2008 book "Mean Markets and Lizard Brains: How to Profit from the New Science of Irrationality."

Burnham is now director of portfolio management for Acadian Asset Management, a Boston-based firm specializing in active global and international equity strategies. He says investors should understand a part of their brain that reacts impulsively to stress and fear. He calls it the lizard brain because it was developed early in the evolutionary cycle to help us find food and retreat from danger, the basic tasks for staying alive.

Even though millions of years later we also have developed the part of our brain that gives us reasoning and logic, the lizard brain often overwhelms us in times of fear, causing irrational behavior.

1. Understand the Enemy Within

Burnham, a presenter at Morningstar Inc.'s annual investment conference on Friday, said step one toward becoming a better investor is to stop blaming outside sources and realize that human nature makes us ill equipped to manage money.

"Lesson number one is the enemy is you," he said. "Your brain is not a silly organ designed to bankrupt you. It is an amazingly efficient machine. It's just built to do something other than to manage money."

He said the sooner investors realize emotional investing is a losing proposition, the sooner they'll improve their performance.

While the emotion centers of the brain are an investor's enemy, the best ally is also in the brain — the prefrontal cortex — the part of the brain that gives us decision making skills and the ability to sort out conflicting thoughts.

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