Most debates in investing focus on strategy: active or passive; hedge funds or private equity; gold or inflation protected bonds. But while these debates are important (and fun), the most important element of investing success is your behavior. Trouble is, culture (e.g. markets) evolve quickly, but human beings evolve very slowly. We are left with bodies and brains that are optimized for a world that doesn’t exist anymore. The famous psychologist Phil Zimbardo wrote a very interesting book called The Time Paradox, from which I’ve pulled two of my favorite quotes:
YOU ARE A LIVING ANACHRONISM Because of the rapid change in the world around us since our birth, we humans are living anachronisms. Our world has changed dramatically in the past 150 years. Human physiology, in contrast, took millions of years to create and has not changed much in 150,000 years. Your body—even if it is in mint condition—is designed for success in the past. It is an antique biological machine that evolved in response to a world that no longer exists. Although we live in a world in which computer processing speed doubles roughly every twenty-four months, human information processing has not expanded substantially over the past 150,000 years. Our physiology is clearly behind the times.
As markets and technology get more sophisticated, we are being left in the dust.
We are hertz machines in a megahertz world. For an average human, simple reaction time is about 250 milliseconds. Simple reaction time is the time that it takes to react to a stimulus, such as a light going on when a button is pushed. Therefore, each “cycle” of light input and button depression response takes a quarter second. Four complete cycles can take place each second. Thus, a typical human has a processing speed of about four hertz. In comparison, modern desktop computers have central processing unit (the brain of a computer) clock speeds of over three gigahertz; they are roughly 750,000,000 times faster than we are. This relatively slow processing speed has two important implications. First, it means that all of us live more than 250 milliseconds in the past.
What this means for you, the investor, is that your body/brain will push you to make foolish decisions because your brain reacts to market threats and opportunities just like it did hundreds of thousands of years ago in the savannah.
My suggestion is to remove yourself from the equation as much as possible by making your investment plan automatic. Instead of trying to time the market, you should instead contribute automatically to your 401(k) and other investment accounts with every paycheck—even if the amounts are small. Instead of trying to rotate between asset classes, pick an allocation and stick to it with scheduled rebalances. These simply tactics cut out the main investing obstacle: you!