B. The ‘Total Body’ Risk Response And Its Priority To ‘Take Action First And Think Second’
· In a natural world environment, when our innate risk/threat response system is activated, our bodies freeze first to asses the immediate threat and see if it passes. If not, it then moves to “taking action” with the flight response, and finally, if flight isn’t effective to use fighting as a last resort.
· In the non-natural world of investing, although the biological freeze, flight, fight reaction may be triggered by market downdrafts, it’s important for long-term investors to be mindful that periodic temporary market downturns are normal and to be expected. It’s critical that they learn to place their “real world,” powerful, full body, biological freeze, flight, fight responses in perspective. By preparing for and then resisting the normal and natural emotional drive to take action first when operating in the volatile, non-natural world of investment markets, we can help our investors learn to avoid taking such actions that are counter to their own best interests.
C. Understand And Avoid Our Costly ‘Risk/Reality Perception Gaps’
· Behavioral scientists have demonstrated a curious, universal human trait of people worldwide (regardless of culture, race or gender) to perceive many risks as greater or less than they actually are. Which can frequently and unknowingly contribute to flawed risk/reward decision-making.
· Although there are more than 20 of these risk misperceptions documented, it’s important that we help investors recognize and avoid those risk misperceptions that have the greatest potential negative impact on investment decision making. Reacting to the following four situations where behavioral scientists have proven that we humans incorrectly perceive risks as much greater than they actually are is especially problematic for investors.
Situations Where Risk Is Perceived to Be Much Greater Than Reality:
1. Large-scale consequences
2. New, unfamiliar, not understood
3. Beyond our perceived control/influence
4. Not expected or occurs\ suddenly
These extreme risk misperception situations are particularly problematic in investing. Not only can any one of them generate a perception of greater risk than reality, all four of them can and have occurred simultaneously within a single trading day. In such simultaneous cases, investors’ misperception of risk can literally “shoot through the roof.” The most effective way to neutralize the negative consequences of acting on these extreme risk misperceptions is identifying, understanding and preparing for them in advance.