Should you follow your gut when it comes to investing?
You’ve seen the movies and heard the anecdotes — a stock market genius goes against the status quo, despite constant skepticism and disbelief, and ends up making millions of dollars because he ‘just knew that it would work out.’ This popular arc gives the impression that the only way to make money investing is by going with your ‘gut instinct,’ but is that really true?
Is gut instinct real?
Many animal species run entirely on instinct. They know when they have to eat, protect themselves, or find shelter. Humans also have this base instinct, but with highly developed brains, we can use this instinct to make decisions that don’t directly pertain to our survival. In fact, you’d be surprised at just how far reaching these instincts are. Forbes published an article explaining that your gut instincts are a driving force behind all of your career decisions.
When it comes to investing, it is entirely possible that some people have a gut instinct that guides them. However, it is more likely the case that emotions (such as fear and doubt) and biases are running the show, disguised as “instinct.”
Is it a good idea to follow your gut in investing?
It is natural to want to let your instincts take over, especially if you’re doing something new and unfamiliar. After all, having survived and evolved through the last 100,000 years, your instincts are probably more likely to guide you to safety and success. On the other hand, your gut is not intellectual, and the decisions that go into saving and investing are rather complex.
There are numerous studies that show that our physiological system cannot tell the difference between real and perceived threats. So if you were in the middle of the 2008 crash, sweating and panicking as you saw your investments plummet, your “gut response” would’ve been to flee as quickly as possible. You would sell your investments, missing out on the subsequent gains in the market.
The truth is that your investment decisions are not among the choices you should make on gut instinct. Instead, focus on growing your knowledge base in order to make educated, research based decisions. Otherwise, you might simply be gambling instead of investing.
When investors are choosing stocks to invest in based on what companies they feel might be successful, they might be getting influenced in any number of subconscious ways. For example, they might be driven partly by the positive or negative attitude they have towards certain companies’ products and brands. If they are trying to decide between two companies that have similar fundamentals and products, an investor might ‘instinctively’ pick the brand that their local supermarket offers.
Some companies do produce superior gains and returns – this is easily observable in the market. However, it is just as true that many companies will go out of business or produce significant losses. Investors are more likely to remember the popular companies that do well, even if this familiarity in no way predicts future returns.
On the flip side, many investors can feel overwhelmed by market volatility. A 2017 survey by Ally Invest found only one in three millennials is investing in the stock market because they find it “scary or intimidating.” And a 2018 Gallup poll found less than half of young Americans are putting their money in stocks because of the 2008 market crash. Their prior experiences might be coloring their investment worldview, whereas they might recognize it as a “gut feeling” that the market will fail again.
The solution: Use your intuition but take advice at the same time
When Google’s early investors advised Sergey Brin and Larry Page to bring in an experienced COO, the two founders instinctively opposed the idea. But, they eventually decided to take the advice and meet some candidates. One candidate happened to be a regular at Burning Man, just like Brin and Page. So, they made a gut decision to hire Eric Schmitt and history has proved that their intuition was correct.
This is a great example of when to take advice while still relying on your gut to make the right choices. The balance between your gut instinct and taking advice from experts is the sweet spot – whether it be high-stakes business decisions or investment decisions.
Whether you’re new to investing or have been in the market for years, the best way to make any investment decision is to be deliberate and calm while looking at the big picture. Rather than cherry picking individual companies to invest in, you could minimize the impact of your emotions by investing in index funds. Index funds not only offer low fees, but follow quantifiable, benchmarked ‘rules’ when it comes to investing decisions.
Obviously, there will still be some choices to be made along the way – you might have to decide which index funds, asset classes, and timelines to invest in. As the market fluctuates, you might be faced with the decision to hold or sell. A rules-based, systematic approach will root out highly emotional decisions and relieve you from having to make decisions under stressful situations, while still giving you the flexibility of going with some instinctive decisions.