Sir Isaac Newton, as everyone knows, was a genius. His endless curiosity led him to tackle problems as minuscule as rug-peeing cats and as grandiose as humanity’s ultimate purpose in the cosmos. Naturally, we might think that a person this smart would also be a genius investor, someone who’s able to outguess the markets and become a multimillionaire with his investment acumen.
But Sir Isaac Newton was no outlier when it came to investing. He started out well enough by investing some of his money into the South Sea Company, a hot stock of the seventeenth century, and sold the stock for a handsome profit. But the stock continued to rise after he sold it. Initially, Newton resisted reinvesting his hard earned money back into the stock, but it continued to rise even higher, and that’s when the trouble began. As the stock price kept going up, Newton started to experience the all too human emotions of envy, regret and greed which often get investors into big trouble.
As the stock climbed, he plowed all his money back into the South Sea Company and shortly afterwards, the stock crashed, and he lost a fortune. By some accounts, he lost the equivalent of almost $3 million, adjusted for today’s dollars. Reflecting on his loss, Newton was quoted as saying, “I can calculate the motion of heavenly bodies but not the madness of people.” He blamed others instead of himself for his stock investing folly. But he simply let his emotions get away from him. He moved from being an investor to a speculator and a gambler. He gambled away a fortune, and as the saying goes: the house always wins.
If Newton had lived in modern times, he may have learned from social scientists that human beings are not wired to invest in the stock market. In times of stress, our primitive brain, which is responsible for survival behaviors such as flight or fight, kicks in. The primitive brain really starts to go haywire when we are losing money, or we feel like we are in danger. It for sure comes in handy if we smell smoke in our house, but it can cloud our judgment when it comes to our investment decisions.
Humans also have another behavioral bias called the “recency” effect. That is, we tend to apply a higher probability to things that have happened recently. Think back to earlier this year when the Dow Jones Industrial Average dropped over 1,100 points in less than a month. Many people thought that we were going to have a replay of 2008 when the market dropped about 40%, and they panicked. Of course, we didn’t go into another recession, and the markets recovered.
As Sir Isaac Newton proved, the smartest guy in the room is often not the smartest investor. Newton didn’t have discipline or a goal-oriented plan; he just kept jumping in and out of the market. Like Newton, our emotional behavior can blow up our plans. Worse, it’s almost impossible to identify this behavior in ourselves. Even if we could recognize it, we can’t turn our primitive brains off to think objectively. That’s why you should work with a trusted financial advisor who is not emotionally attached to your money and can think objectively. A good advisor will keep you disciplined and focused on your goals and not let your emotions drive your investment decisions. And unlike Newton, a good advisor won’t gamble away your money.
To learn more about Jeff Bogart, view his Paladin Registry research report.
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