The subtitle of Your Money & Your Brain by Jason Zweig (Simon & Schuster, 340pp) is How The New Science of Neuroeconomics Can Make You Rich. No doubt the publishers needed to spice up the cover a bit, because the book might have been better subtitled, “How to stop your brain from screwing up a slow and steady investment strategy.” This is one investment book that won’t give you advice on how to beat the market, how to pick a hidden winner, or how to use leverage to boost your returns. Indeed, most of the investment advice Zweig offers is downright boring, like “create a self-balancing portfolio of funds and don’t look at it too often.” Happily for readers of Neuromarketing, though, there’s a plethora of fascinating neuroscience tidbits that provide great insight into the sometimes strange ways our brains work.
Zweig’s basic premise is that our the function of our brains evolved to serve early humans in their quest to survive in a sometimes hostile world. While few can argue that humans have succeeded in dominating the planet, our brains haven’t quite kept pace. We still react to investment news and make decisions with the same mental firmware that allowed our forebears to avoid getting eaten by large carnivores, and that often leads us to poor investment choices.
One interesting tack Zweig takes is to sharply disagree with Malcolm Gladwell and his book Blink. Zweig doesn’t do this in a bad way, though – he simply points out that making investment decisions is one area where intuition and snap judgments simply don’t work and where our first reaction is usually the wrong one. Warren Buffett, one of the few investors to beat the market consistently, is known for his dispassionate, analytical number-crunching and measured decision-making process – he wouldn’t acknowledge intuition as part of his process. (I do wonder, though, if after a lifetime of analyzing companies Buffet might not be a pretty decent thin-slicer. It wouldn’t surprise me in the least if Buffet often tags a company as a winner or loser on his first visit to the firm, and then grinds through the due diligence to confirm his thoughts and look for hidden land mines in the deal.)
Zweig points out the foibles of our investing brains, which are programmed to find patterns in the world around us. That may be good for coping with the natural world, but it is less useful for investing. For one, we leap to conclusions. If something happens twice in a row, we automatically project a third occurrence. We do this automatically and unconsciously. Our “prediction” circuits are driven by the release of dopamine, a powerful brain chemical related to pleasure and rewards. This is one reason why people are drawn to stocks that keep going up; unfortunately, this neural extrapolation is usually setting us up for a fall. Zweig offers a variety of ways to avoid basing investments on false predictions, ranging from dollar cost averaging to dispassionate analysis of the facts.
Our reward and fear programming also serve us poorly. Hear a hot tip about a stock that’s going to double? Your brain starts anticipating the big gain, and wants to chase it. Got a stock that has dropped rapidly? Your fear programming kicks in, and you want to dump the stock to prevent more losses. Is everyone else selling? You want to join the herd. All of these reactions may have been useful in our hunter-gatherer days, but now they are rarely profitable investment strategies.
Motley Fool has just published an interesting and lengthy interview with Zweig – the first part is here.
Your Money and Your Brain may not be an exciting investment guide (clearly, my brain craves the dopamine kick of riding a winner to gains in the hundreds of percent), but it is a highly readable and fascinating guide to the human brain’s decision-making process. I highly recommend it not just for investors, but for those interested in neuromarketing and neuroeconomics as well. In future posts, I’ll highlight some tidbits of particular relevance to marketing and consumer behavior.
The evidence is that investment success is largely luck/random. However, the myth of investment skill is one that feeds our craving for predictability. Understandable, but like so many myths harmful when applied to real-life.
BTW, the evidence is the same for other professions.