Nov. 28, 2011 -- Women are better wired than men to avoid emotionally driven investing mistakes.
This conclusion, by Richard L. Peterson, a psychiatrist who studies the role of emotions in investing decisions, would likely be rejected as ludicrous by the huge male egos on Wall Street. Yet these masters of the universe should know that Peterson's findings aren't based on inference or speculation. Rather, they're supported by neuroscience.
Peterson found evidence through a study of thousands of investors that because women are more in touch with their feelings, they're more able to control how their emotions might weigh on their investing decisions and to avoid mistakes. His research has been published in leading academic journals.
The good news for men is that they can reduce these mistakes by getting more in touch with their feminine side. "If investors carefully examine their feelings when they make decisions and review them later, they can improve their process," says Peterson, author of Inside the Investor's Brain (Wiley Trading, 2007) and co-author of MarketPsych: How to Manage Fear and Build Your Investor Identity (Wiley Finance, 2010).
Peterson's findings, summarized in a white paper, challenge the classic financial rule that emotions have no place in investment decisions. He has found that the role of emotions in investing can actually be positive — if you're sufficiently aware of them.
His research is based on brain scans of subjects showing emotional changes in color-coded images. These scans show spikes in fear or greed, indicated by increases in blood oxygen levels, stemming from increased uncertainty or new information during simulated investing scenarios.
"Emotions are central to all financial decisions," says Peterson, who has compared the scans of successful investors to those of average ones. "Mistakes happen when there is too much emotion, causing investors to overreact to new information by buying or selling when they shouldn't. We see this in the brain imaging. But we also see that mistakes occur when there isn't enough emotion."
By this, Peterson means that investors often aren't fully aware of emotions driving their decisions. If you attempt to be completely objective by blocking out all emotion, he says, you won't recognize your feelings. As a result, you won't be able to temper the impact of emotion on decisions or to actually use it to make better decisions.
"Sigmund Freud found that if you repress emotion, it will eventually come out in other ways," Peterson says. "You have to recognize the emotions that you're feeling. By understanding what you're feeling you can overcome or reduce the tendency to be driven by these emotions in your decision-making. But if you deny the existence of these emotions, they'll come back to haunt you."
For men, Peterson has found, this emotional boomerang comes back more often. "Men, being characteristically more prideful and overconfident, tend to take too much risk, and they over-trade," says Peterson, managing director of MarketPsych LLC, a training firm for financial advisors.
"When they're making money, instead of letting winning stocks run, men are more likely to sell too soon because they want to feel good about themselves," he says. "They don't have a demonstrable winner until they sell at a profit. And more than women, men are predisposed to leave their losers open because they want them to rebound. For men, mistakes are harder to admit."
Peterson, whose research involves personality testing, has found that men tend to have much greater lifetime declines in asset value than women; men take more risk so they suffer more on the downside.
Women, by contrast, tend to take fewer risks than men — which can mean smaller losses. By listening to their emotions instead of repressing them, Peterson says, women can actually use their feelings effectively in investing decisions.Because women are more aware of the impulses triggered by the emotion of greed, they're more likely to resist the impulse to overreact by trading too much on new information. Instead of being driven to sell quickly by inner fears, women are more likely to stop and examine these fears. So they are less likely to succumb to internal pressure to sell during market panics or to jump on the bandwagon during rallies.
And by listening more closely to their feelings, they are better able to harness them to enable fruitful intuition. Investors who fail to do so may miss out on market gains because they didn't bring enough emotion — of the right kind and in the right measure — to their decisions.
Peterson points out that the tendency of women to be more emotionally attuned is not a matter of mystery, but of biological science: Women have higher levels of oxytocin, a hormone linked with empathy. They also have a thicker corpus callosum—the band of white fibers connecting the two halves of the cerebrum—than men. This may make women more self-aware and may equip them better for multitasking.
Short of taking oxytocin injections, how can men enhance their emotional sensitivity to get a handle on feelings that may be dominating their decisions?
Peterson advises both genders to chronicle their investing decisions and related emotions by keeping a journal and documenting the process, including their feelings at the time. When you buy a stock, for example, record the reasons why and the emotions you feel at the time. Later, go back and review these decisions and try to evaluate the role of emotion versus other factors.
Getting more in touch with investment-related emotions can be part of a broader process that leads to greater emotional self-awareness in all aspects of life. Understanding how emotions drive your behavior is a key to understanding how you feel about yourself and relate to others. Thus, you can strive to be happier as well as wealthier.
Ted Schwartz, a Certified Financial Planner®, is president and chief investment officer of Capstone Investment Financial Group. http://capstoneinvest.net. He advises individual investors and endowments, and serves as the advisor to CIFG Funds. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on achieving their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at firstname.lastname@example.org..