Retraining Our Brains

by: Richard A. Anderson

Last November I was rear-ended on my drive home from work. I was stopped at a red light when the driver behind failed to stop. Luckily, I was not injured in the accident, but it was scary nonetheless. Less than one month later, I was driving down the highway to return the rental car I needed while my car was at the body shop getting repaired and I was once again rear-ended. Not being at fault, I was lucky to escape the accident with no physical injuries.

Prior to these two events, I was never involved in a car accident. Even though neither accident was my fault and I was uninjured in both incidents, nearly nine months later the accidents have left a mental mark on my psyche. I find myself driving more defensively and being more aware of my surroundings. Whenever I am stopped at a red light or slow down when hitting traffic on the highway, I look in my rearview mirror to make sure the car behind is going to stop. I may have been naive for not doing these things before the accidents, but I guess you don’t think about these things until after an event occurs.

Our brains are amazing. They are designed to help us avoid repeating mistakes. Have you ever dropped a glass cup? The next few times you pick up another glass you tend to be extremely careful to avoid another accident. But that carefulness tends to wear off quickly. Driving more defensively is my brain’s way of helping to avoid another accident, but I am not sure if that will ever go away.

I also cannot help but see the comparison to investing following a market crash. Most of our clients have lived through two major prolonged stock market downturns: the Tech Bubble and the Great Recession. Following each one of these events, investors have tended to be much warier of risk. They tended to shun the risks that caused the previous market downturn.

Yet, as Greg Ip wrote in his Wall Street Journal article The Financial Crisis Made Us Afraid of Risk - For a While, probably the most important lesson of financial history is that, “risk-taking never disappears, it just changes shape, ceaselessly to slip past the institutional and psychological defenses erected after the final crisis.” We avoid the investments that caused us so much pain, only to open ourselves up to other risks that will cause us future pain. Following the Tech Bubble, it was technology stocks. Following the Great Recession, it was buying expensive real estate with little or no money down. The next market crash will be caused by some other unforeseen risk.

This month marks the ten-year anniversary of the collapse of Lehman Brothers. The bankruptcy of Lehman Brothers on September 15, 2008 is recognized as the triggering event that caused the worst economic crisis in living memory. Ten years later, the scars of the financial crisis remain.

A study conducted by Vanguard published in June 2018 entitled “Risk-taking across generations” analyzed 4 million Vanguard retail investor households holding a combination of IRA and taxable accounts to assess the level of risk-taking. Among the key notable results was that there has been a shift toward more balanced strategies. Investors have moved away from 100% stock allocations in favor of strategies that allocate funds to both stocks and bonds.

This trend is seen across all generations but is most drastic for millennials. For millennials who opened accounts at Vanguard in 2007 or before, 33% have all stock portfolios. For millennials who opened accounts at Vanguard in 2008 or after, only 14% have all stock portfolios. Even worse though, is the number of millennial investors with no stocks in their portfolios. For millennials who opened accounts at Vanguard in 2007 or before, 10% have portfolios with no stocks. For millennials who invested after 2007, 22% have portfolios with no stocks.

A survey conducted by Gallup that appeared in Barron’s found similar results. Across all age groups, the percentage of individuals with money invested in the stock market (either through individual stocks, mutual funds, or exchange-traded funds) has declined. In 2007, 65% of Americans owned stocks. In April 2018, that number had fallen to 55%.

There are some investors who have been so traumatized by the losses they experienced in previous market crashes that it has forever changed the way they invest. This isn’t necessarily a bad thing, as it is natural to learn from our previous experiences. However, for those who have become too conservative or never even began to invest, there is the potential of trading stock market risk for the risk of not being able to meet future financial goals. Bringing this full circle, we don’t stop driving all-together after we have been in a car accident. We may drive more cautiously and have greater awareness of our surroundings, but we still get behind the wheel because it’s the most efficient means of transportation.

The same can be said about investing. We shouldn’t stop investing all-together or change our habits too drastically that it affects our ability to meet our financial goals. After all, stock ownership has proven to be the most efficient means to grow our wealth.