Posted by on Aug 5, 2013 in Blog, Columns, Featured |

By Jason Zweig | 7:06 pm ET Aug. 2, 2013

Image Credit: Christophe Vorlet

The bull market is starting to look like a stampede.

After taking more than 13 years to climb to 1600 from 1500, the S&P 500 index of big U.S. stocks didn’t even take 13 weeks to add the next 100 points. On Thursday, just 90 days after rising above 1600, the S&P 500 closed at 1706.87, the 24th time it has hit an all-time high this year; on Friday, both the S&P 500 and the Dow Jones Industrial Average again set record highs.

Counting dividends, the S&P 500 is up 177% since the lows of March 2009—and many investors can’t stand watching anymore. After years of withdrawals, money is finally coming back into U.S. stock funds, with more than $7.5 billion pouring in last month, according to the Investment Company Institute, a trade group.

Some investors undoubtedly are telling themselves, “I’ll know when it’s time to get out” or “I’m a long-term investor, so a short-term drop in the market won’t bother me.”

When stocks are going up, it’s easy to imagine that you will stick to your plan when stocks go down. And it’s hard to imagine that in the next market panic, the heat of the moment could reduce your resolutions to ashes.

A new study sheds light on why people who “precommit” to structured decisions that lock them into a plan are better able to stay the course than those who rely on willpower alone—and how precommitting might be rewarding in itself.

In the research, just published in the journal Neuron, a team of neuroscientists based in England, Germany and Switzerland sought to learn more about what enables people to wait longer for a larger reward instead of grabbing a smaller profit sooner.

When Ulysses asked to be tied to the mast to resist the song of the sirens, he was precommitting to stay put no matter what—because he knew his willpower might weaken at the worst possible time.

Investors can tie themselves to the mast, too, with structures that lock you into a decision and impose a cost if you change course—mutual funds with redemption fees to deter short-term trading, certificates of deposit with penalties for early withdrawals or “dollar-cost averaging” plans that automatically sweep a fixed amount from your bank into a fund every month.

In the study, participants sometimes relied on willpower alone to wait longer for a larger reward. Sometimes the same participants could precommit by choosing to make the smaller, earlier prize unavailable—and unable to tempt them as they waited for the larger reward.

For the 78 men in the study, aged 18 to 35, the rewards were glimpses at photos of scantily clad women; some (the “larger” rewards) were more attractive than others (the “smaller” rewards). Images of the opposite sex, many experiments have shown, activate the same areas of the brain that respond to financial gain.

Unsurprisingly, the men were much less likely to defer gratification when they relied only on willpower than when they chose to precommit.

Another result was surprising. When men who found it “quite difficult” to wait for the larger reward chose to precommit, says Molly Crockett, a neuroscientist at University College London who led the study, brain scans showed intense activation in the reward circuitry of their brains.

“Protecting yourself against the possibility that you might turn out to be weak-willed,” she says, may have a “subjective value” to the human brain.

So if you are considering an entry—or return—to the stock market, ask yourself if you are ready to precommit to it.

You could buy a fixed amount every month in a dollar-cost-averaging plan; sign an investing contract, witnessed by family or friends, stipulating how long you will hold your investments; name the account after a goal, such as saving for college or retirement; or craft a checklist that spells out the only conditions under which you would sell.

If you aren’t willing to tie yourself to the mast, you almost certainly don’t belong in stocks at all at this point—since the course may well be far rougher in the future than it recently has been. And your willpower, no matter how firm you think it is, will probably fail you when the market takes a bad drop.

As “Adam Smith” said of the stock market in his classic book “The Money Game”: “If you don’t know who you are, this is an expensive place to find out.”


Source: The Wall Street Journal