Our brains are not designed for good investment decisions
The human brain is a marvelous phenomenon, developed over the years into a highly complex thinking and feeling device, capable equally of flights of poetry or space rocketry.
When it comes to the investment markets, however, it is probably more of a hindrance than a help, says Wall Street Journal columnist Jason Zweig in his recent book, “Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich” (Simon & Schuster, 2007).
Zweig says that the evolutionary development of quick pattern recognition that helps us to flee dangers and size up threats fails us when investing.
Four errors
Scientific research has identified four brain patterns that hurt investors:
- The brain leaps to conclusions on scanty evidence. Two days of rising prices, for instance, will make you expect a third.
- It acts unconsciously. You may feel like you are analyzing something rationally, but your brain meanwhile is reaching an instinctive conclusion.
- It operates automatically. When confronted with randomness, your brain searches for patterns, even if there really are none.
- You can’t control it. You can’t consciously turn off instinctive processing.
J.P. Morgan’s law
The financier J.P. Morgan used to say that every man has two reasons for every decision—the reason he states and the real reason. Our brains sabotage our ability to rationally react to the random information coming from the markets and our conscious reasons for buying and selling often differ from the pattern-seeking reasons offered by our brains, Zweig says.
“Most of us don’t even know why we do things, and we can often be in the grip of unconscious emotion or unconscious biases, feelings, and inclinations that are in our mind but we have no awareness of,” Zweig recently told the Journal of Indexes.
His most important advice: “If the market is open, your wallet should be closed.” Always let at least a day go by before acting on an investment idea. Reevaluate it the next day and see if your mind has changed.