The human mind is the most complex thing in the known universe.
According to IBM's Chief Scientist, it has 38 petaflops (thousand trillion operations per second) of processing power — the equivalent of around 15,000 laptop computers. And it uses less power than an average light bulb!
This incredible apparatus has led our species to split the atom, send probes to Pluto and create breathtaking artistic marvels. Yes, the brain is pretty amazing.
There are however some things that the human mind does badly — very badly — and that can make it rather ill-suited to certain endeavours in the modern world. A great example of this is with investing.
Thinking Long Term
For most of us, it is hard to think long term. Which makes sense; when scratching out an existence on the savannah, there was seldom any need to contemplate anything more than a year out (across the cycle of the seasons).
But that's exactly what we need to do when buying shares. The real worth of your shares goes well beyond its performance in the current reporting cycle, or what issues are presently impacting investor sentiment. Instead, value is determined by what earnings the company can deliver over many, many years.
The daily fluctuations in price really tells us nothing; but because it is in the here and now, because that feeds back to our keen sense of gain and loss, greed and fear, that's what most people tend to focus on. And by doing so, they not only miss the bigger picture, but put their returns at great risk.
A Social Animal
Our brains are wired in such a way as to place great importance on what our peers think and do. And although that's important for social cohesion, it can lead us to do some pretty dumb things when it comes to modern financial markets.
100,000 years ago, when someone in the tribe yelled "lion!", it was usually a pretty foolish caveman that asked for evidence before running. Far better to run first, and ask questions later.
Trouble is, that's usually the exact opposite of what you should do on the sharemarket. Those that blindly follow the herd almost always do poorly.
Spot The Pattern
The brain is great at spotting patterns, and that has proven to be a wonderful adaptation. But in financial markets, where there is a veritable sea of data, it's easy to see patterns where none exist.
We also look for causal links between events, and find it difficult to distinguish between coincidence and correlation.
Don't let yourself be distracted by the seemingly compelling patterns seen on markets (and promoted by some pundits). The only relationship that matters is that, over the long term, shareholder returns follow business performance.
Virtually everything else is noise.
Foolish Takeaway
The wonderful brains that nature has given us are best used to understand the businesses we are investing in. Don't waste all the wonderful processing power conforming to the herd, focusing on the short term and being distracted by irrelevant patterns.
Most people can't, but if you can, you'll be that much richer for it.
