“All our life … is but a mass of habits … bearing us irresistibly toward our destiny.”
— William James
Seven years ago, a researcher at Duke University found that more than 40% of the actions people perform each day aren’t the result of conscious decisions. They’re dictated instead by habits. As a result, if you want to get better at something — in our case, investing — then this is probably a good place to start.
Most of us are habitually bad investors
I think we can all agree that most investors (myself included) have a multitude of bad habits, and that those habits have a detrimental impact on our returns. I’m referring most specifically to the tendency to think short-term, obsessively check stock quotes, and succumb to fear when the market is down and to euphoria when it’s up.
You’ve heard it a million times before: Frequent trading in and out of stocks is bound to produce subpar, if not negative, returns. The evidence is convincing, if not unequivocal. Yet online discount broker TD Ameritrade Holding Corp. (NYSE:AMTD) announced earlier this week that a full 10% of its customers’ trades were done on mobile devices — implying a sense of urgency that isn’t typically associated with long-term investing.
So why do we do this? According to Charles Duhigg’s exceptional book The Power of Habit, “Particularly strong habits … produce addiction-like reactions so that ‘wanting evolves into obsessive craving’ that can force our brains into autopilot, ‘even in the face of strong disincentives, including loss of reputation, job, home, and family.'”
A study cited by Duhigg drives this point home. In response to cues, such as the ringing of a bell, researchers trained mice to press on a lever in exchange for food. Once the habit was ingrained, the food was laced with a substance that made the mice violently ill. The researchers were trying to determine whether the mice would continue to eat the food despite the adulteration.
What do you think happened? As one might expect, the mice quickly learned to avoid the food when it was presented to them in a bowl. Yet when they were confronted with the ingrained cue from before, they couldn’t stop themselves from pressing on the lever and eating the food.
The link between mice and humans may seem tenuous at first. But upon deeper reflection, it becomes obvious that the human world is replete with evidence of analogous behavior. As Duhigg points out:
Consider fast food. … It makes sense — when the kids are starving and you’re driving home after a long day — to stop, just this once, at McDonald’s Corporation (NYSE:MCD) or Burger King Worldwide Inc (NYSE:BKW). The meals are inexpensive. It tastes so good. After all, one dose of processed meat, salty fries, and sugary soda poses a relatively small health risk, right? It’s not like you do it all the time.
But habits emerge without our permission. Studies indicate that families usually don’t intend to eat fast food on a regular basis. What happens is that a once-a-month pattern slowly becomes once a week, and then twice a week — as the cues and rewards create a habit — until the kids are consuming an unhealthy amount of hamburgers and fries.
Thus, to reiterate the point, certain habits are so strong that they “cause our brains to cling to them at the exclusion of all else, including common sense.”
How to fix bad investing habits
How many times have you heard somebody say that they need to eliminate this or that bad habit? My guess is: many times. And if you’re anything like me, you’ve probably said it yourself on more than one occasion.