How do our brains and emotions prevent us from investing?

In the U.S., 62% of adults invest in stocks directly or through funds, while in the EU countries this number is at best 20%. Economist Denis Elakhovsky has studied several studies to understand what prevents us from not only investing, but sometimes even just deciding to open our first brokerage account.

Why do many people hesitate to become investors? There are perfectly rational arguments: the complexity of financial markets for newcomers, lack of current income, high rates on familiar bank deposits, difficulties in calculating and paying taxes, and the like. A new study by German economists from the University of Münster adds another, at first glance not the most obvious reason - psychology.

In short, the main conclusion of the study can be summarized as follows: a consistently good mental state significantly increases a person's chances of becoming an investor. But when anxiety and depression accumulate, people stay away from the stock exchange.

The study is based on the German Socio-Economic Panel (SOEP), the largest annual household survey in Germany: tens of thousands of people answer questions about income, health, education and savings year after year. The study revealed three distinct channels through which the psyche acts on the decision to start investing: expectation of future returns, inner confidence in success, and risk appetite. The higher the level of anxiety among the survey participants, the lower their self-esteem was in all three of these parameters and the less often people decided to take their first steps in the financial market.

The level of trust plays an important role in the decision to start investing. Economists from the American National Bureau of Economic Research (NBER) back in 2005 tested this in a very simple way: they divided people according to the answer to the question - "can you generally trust other people, or is it better to always be cautious?". It turned out that those who chose the "can be trusted" option were about 6.5 percentage points more likely to own stocks. In relative terms, that translates into a nearly 50% higher likelihood of participating in the stock market. Simply put: if you trust it, you invest , if you don't trust it, you sit in the cache.

Sometimes internal beliefs get in the way. The work of Finnish scientists (2022) based on data from 19 European countries shows: if a person strongly believes that financial markets are the business of only the rich or that the risks are too great, even good arguments do not help - he may still refuse to open a brokerage account. For example, survey participants who had a strong "markets are unfair" attitude were, on average, 10-12% less likely to own stocks than those who did not have such a belief, even with comparable incomes and knowledge of investment methods.

The social environment is also important. If it is normal for your friends and neighbors to hold stocks, you are likely to follow their example. But not because of fashion, but because you always have someone to turn to for advice and clarification, so your anxiety level will be comparatively lower. This effect in 2024 is neatly documented by Hong, Kubik and Stein using US data.

In general, there is no single universally accepted theoretical concept to explain the reasons for avoiding participation in the stock market. "The participation paradox" - why many people never get to the point of buying stocks - is the result of a complex combination of personal, psychological, demographic, behavioral, cultural, institutional and purely economic factors. This is shown by analyzing at once 199 profile scientific publications made between 2000 and 2023.

Take it as axiomatic: feelings will always influence investment decisions. Even Vanguard, which popularized the concept of passive investing through the purchase of index funds and ETFs, says in its educational materials that our instincts often push us to do the "wrong" thing: buy when "everyone is happy" and sell when they are scared. Often, the best solutions are to do just the opposite: stay disciplined when the market is rising and resist the urge to sell out during drawdowns. Behaving this way does not mean suppressing your emotions. It means displaying them mirroring the crowd. It's old advice, Warren Buffett gave it publicly 40 years ago, but it's still not easy to follow.

On the other hand, lack of fear is a very serious contraindication for starting investing. People with damage to the amygdala (an area of the brain involved in regulating, among other things, the feeling of fear), when choosing between relatively safe and more risky gambling most often choose the latter, showed a study by American neuroscientists Antonio Behar, Hannah and Antonio Damasio and Gregor Tim, published in 1999. The inability to experience fear makes such people strive to win, disregarding the increasing probability of losing big.

A 2014 study by scientists from California and Virginia Tech found that increased activity in the anterior insular lobe of the brain (which forms our subjective state based on internal sensations like thirst, hunger, pain, heart rate or body temperature) helps us recognize critical stages of a market bubble in time. In an experiment in which people had to decide whether to continue buying a stock that had already risen to 10 times its fundamental value, those whose insular lobe was working more intensively were more likely to sell the stock before the correction began.

These conclusions are confirmed by a study conducted 10 years ago by British and Australian neuroscientists and economists, which showed that professional traders who better assess their own physical and emotional state, over time show a higher average daily profit, and their career in the market is often longer.

Of course scientists couldn't help but drag investors into the MRI machine. One such experiment recently conducted in the Netherlands showed that real professionals can make successful investments simply on a subconscious level. Researchers measured activity in the contiguous nucleus (also called the "pleasure center") in those who chose stocks. It turned out that the higher the activity was, the more likely it was that the selected stocks would then show better performance.

The practical conclusion from all these scientific works, perhaps, can be formulated as follows: it is easier for a person to decide to start investing when he or she feels comfortable making decisions. Otherwise, even the most rational and profitable plan will tend to be sabotaged by the consciousness. And if you have already made up your mind, you should listen not only to the arguments of reason, but also to your emotions. If they are interpreted correctly, they can help a lot.

What can be done?

Find a social outlet. Agree with a friend or colleague to discuss your finances once a month or quarter. This adds confidence and discipline.

Lower your entry threshold. Do not rush into a large portfolio of different assets at once. Let it first be shares of a well-known index fund with low commissions. And if you set up an automatic monthly purchase for a fixed amount, you will not have to argue with yourself every time whether it is a good time to invest.

Eliminate unnecessary noise. Limit the news stream on your phone to facts. The less cause for alarm, the easier it is to stick to the plan. There will be drawdowns in any case. Decide in advance: during drawdowns, the portfolio remains unchanged until the scheduled review date. This protects both your psyche and your money.

Learn to recognize your own body signals. All this research about "amygdala bodies," "insular lobes," and "pulse sensitivity" can essentially be boiled down to one practical conclusion: always pay attention to your state of mind. Are you overexcited? Or, on the contrary, paralyzed by fear? Close the trading terminal and postpone decision-making until you return to normal. And with it, to a well-thought-out action plan and strict discipline.

This article was AI-translated and verified by a human editor