Pain Reliever: The Behavioral Case for Defensive Equities

Human behavior can lead to irrational investment decisions, but a well-planned low-volatility strategy may be the antidote.

Human behavior isn’t always rational. Perhaps that’s why so many otherwise thoughtful investors make irrational decisions—locking in losses by selling at the worst possible times or chasing stocks with overextended valuations. Is there an investment strategy that can help offset emotional behaviors that can lead an investor astray?

The Three Layers of the Human Brain

To get to the heart of why investors make irrational decisions, it’s instructive to consider the human brain and its response to pleasure and pain.

Our brains have evolved over millions of years and consist of three layers. At the core is our primitive brain, which provides the fight-or-flight instincts that keep us alive. Overlaying this is a more evolved mammal brain—the source of emotions, memories and habits that aid our decision-making. The highest level of brain function is the neocortex, which helps us process thought, reasoning and self-reflection. This is what essentially makes us human.

Signals from the primitive regions of our brains prompt us to seek pleasure while avoiding pain. But these same signals can overwhelm the neocortex and cause us to behave irrationally. Further knocking our reasoning out of kilter is the human propensity to fear pain much more than we enjoy pleasure.

In the investment world, this can result in some puzzling decisions.