“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”
—Charlie Munger, interviewed during the Great Panic of 2008-2009
When we’re constantly inundated with breaking news and catchy headlines, it’s difficult to consider life beyond the daily news cycle. But a short-term mindset can destroy an investment portfolio. Paying attention to short-term market changes leads investors to imagine the worst possible outcomes and make terrible decisions.
Ignoring short-term volatility is the key to reaping high rewards in the equities market. But how does anyone do it? The answer is to think long-term, although it’s not easy.
Your brain is your worst enemy
Short-term changes in the market trigger emotional responses, often leading to poor investment decisions. Responding to negative market returns with equanimity isn’t easy. Indeed, human biology is working against us.
When we see the stock market drop, our brains release adrenaline, signaling stress, fear and anger in a process that has been part of our biology for millennia. The emotional responses our ancestors experienced when being chased by lions were similar to what we feel when watching our portfolios during a bear market.
Conversely, when we see the stock market rise, our brains emit a burst of dopamine, the reward chemical. Dopamine also figures in the fight-or-flight response. Together, spikes in adrenaline and dopamine dominate our emotional responses to the market.
Overall, the negative emotions triggered when we lose money are much stronger than the dopamine rush we get from making money. We feel the need to do something¾whether that’s running from a lion or selling poorly performing stocks. Long-term thinking is a huge challenge for our caveman brains.
Check the market once a year, not once a day
Successful investing is a long-term endeavor. The stock market doesn’t go straight up, so the more often you check your accounts, the more likely you are to notice negative returns and jeopardize your portfolio by selling when the market is down.
As the chart below shows, the chance of a negative stock market return for any 1-year period is 1 in 4, but over 5 years, it’s just over 1 in 8. Historically, there’s never been a 15-year stretch when the stock market has had a negative return. In other words, the longer the holding period, the lower the likelihood of a decline in value.
Since the end of WWII, there have been bear 12 markets, or about one every six years on average. During this span, the average peak-to-trough decline has been about 34%, with a duration of just over a year. Naturally, this causes investors to panic over short-term “losses”—otherwise known as temporary declines in value. Although history demonstrates that the market will recover in time, the brain’s wiring incites an immediate response to sell.
J.P. Morgan recently published a table highlighting a notable apocalypse du jour for each year going back to 1999 (Y2K) through 2021 (COVID-19/omicron). The right-hand column shows the cumulative total return of the S&P 500 from December 31 of the year prior through January 31, 2022. Consider the opportunity lost over time by selling in response to any one of these end-of-the-world events. Sadly, this is the natural reaction of the untrained investment brain.
Warren Buffett said, “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.” The benefits of thinking long-term lie in the high returns of the stock market over decades-long periods. But, as countless studies and data demonstrate, individual investors have a difficult time holding onto stocks and ignoring market fluctuations.
DALBAR, Inc. explored the impact of emotions on investment decisions by analyzing the timing of mutual fund flows. The financial research firm calculated the return achieved by the average investor over a 20-year period and concluded that most investors attempt to time the market despite being very bad at it. DALBAR found that the average investor underperformed an indexed 60% stock/40% bond portfolio by 3.5% per year. For every $100,000 invested in 2001, the average investor missed out on nearly $170,000 in gains by the end of 2020.
The takeaway: Those who actively trade in response to market volatility sabotage their chances for greater returns.
Prioritizing long-term rewards over short-term gains has always been a difficult hurdle for the human psyche. But the ability to delay gratification plays a role in portfolio success, because exchanging short-term gains for long-term rewards is key to reaping the benefits of stock market performance.
In a study comparing the brains of professional investors, senior investors displayed more dopamine pathways and a stronger presence of the genes responsible for stress hormones than younger, less experienced investors. Essentially, senior investors have better developed biological processes for evaluating stock market risks and rewards. By thinking long-term over the long-term, investors changed the physiology of their brains.
Average investors and professional investors all assess risks (however defined) and rewards. Whether fears get in the way of rational behavior is the key differentiator between poor and successful investment strategies.
People think about the future in different ways. For some, long-term means a few years, while for others it implies generations. Although your definition of long-term can depend on your investment goals, it’s important to remember that stock market volatility is a short-term consequence in a system that inevitably yields payback in the long term. Checking your portfolio once a year instead of once a day is a great starting point in reshaping how you consider your finances. In time, you’ll retrain your brain to think in decades instead of days.
If humans were perfectly rational beings, more people would recognize the value of thinking long-term.
But training your mind to do so is difficult because it requires working against your own biology.
To become successful investors, we must retrain our brains to think in multiyear horizons, but it’s most important that we reassess how we behave in the face of different emotions. By recognizing our immediate fear response for what it is, we may gradually learn to reframe our finances over the long term.
Our brains are wired to send us immediate signals of fear and reward when we witness stock market volatility. Adrenaline and dopamine rushes cloud our judgment as we weigh the risks and benefits of our options. Ignoring fear or delaying instant gratification is incredibly difficult because it demands that we go against our instinctual behaviors. But if we train ourselves to think long-term, we can reap tremendous rewards. When it comes to investing, we are not rational; our brains are our own worst enemies.
Gabby McClellan is a student at Harvard College (class of 2024) who made significant contributions to this essay.
 Ortiz-Teran, E., Diez, I., Sepulcre, J. et al., Connectivity adaptations in dopaminergic systems define the brain maturity of investors,” Scientific Reports, June 2021.