Becoming a Better Investor: Stress-Influence Tendency

Legendary investor and former Berkshire Hathaway Vice Chairman Charlie Munger is known for his valuable advice when it comes to money and investing. In his famous speech “The Psychology of Human Misjudgment,” Munger laid out 25 psychological tendencies that distort our thinking and influence our behaviour. He believed that by understanding the effects of these tendencies,  we could avoid making poor decisions in investing and life.

This week, we’re looking at the seventeenth tendency, the Stress-Influence Tendency, how it impacts us, and how to avoid it.

What is it?

The Stress-Influence Tendency is simple, yet profound: when under pressure—be it fear, anxiety, pain, or uncertainty—human behavior changes dramatically. Munger noted that even smart people make poor decisions when stressed.

Munger illustrates this with the example of Russian physiologist Ivan Pavlov and his experiments with dogs and Pavlovian conditioning. During the Leningrad Flood in the 1920s, Pavlov had several dogs in cages. Their behavior had been shaped into distinct patterns using a combination of his Pavlovian conditioning techniques and standard rewards. But when the floodwaters rose, some dogs were trapped in their cages with almost no space to breathe, causing extreme stress. Once the flood waters receded, Pavlov noticed the dogs’ behavior had changed dramatically. For example, a dog that used to like its trainer now acted aggressively toward him. These sudden changes were similar to how people can quickly turn against their families when they join a cult. The point is: when we are under extreme stress, our thinking and behaviour changes drastically.

How does it play out in the world of investing?

Stress is something that we deal with on an almost-daily basis in today’s world. And according to Munger, stress is the enemy of objectivity. He says that under stress, especially severe stress, we are prone to misjudgement, irrational behaviour, and thinking short-term. While small levels of stress can push us to do better, heavy stress can hijack our ability to think clearly and calmly.

To quote Munger,

“… light stress can slightly improve performance — say, in examinations — whereas heavy stress can cause dysfunction.”

So when it comes to investing, working under stress can cause us to make the wrong moves. Panic selling during crashes, overreacting to short-term performance dips in a company, chasing a company after a missed opportunity — these are all examples of acting from the Stress-Influence Tendency.

Ups, downs, and risk-taking are part of investing and can’t be ignored. But investment decisions taken under stress can be an even bigger risk. So how can we guard against acting out of stress? By managing that stress with rationality.

• Have a rulebook: We may call it a rulebook, checklist, or framework, but we need to set rules for how we invest. A checklist that can be referred to to make sure we are investing for the right reasons, irrespective of how we may feel at that moment. A clear system can save us from stress decision-making.
• Learn more, gather more data: Stress and uncertainty are often intertwined. When we understand the why of our investments and our investment strategy, we are less vulnerable to irrational decision-making when we are under stress.
• Volatility is an opportunity: Price dips and market volatility don’t need to lead to panic selling. It can also be an opportunity to invest in different companies that we may not have considered before, at a better entry point.
• Liquidity matters: Having enough liquidity and ample reserves prevents us from getting emotionally reactive. An emergency reserve allows us to invest with confidence, weather the volatility, and stay calm during downturns.

Stress explains why sometimes, even the most rational investors make bad choices and end up losing out. Market turbulence and volatility can be unpleasant, but they don’t necessarily spell the end. With the right mindset, systems, and preparation, we can ride it out and profit in the long-term.