Is Your Brain Helping or Hurting Your Bottom Line?

Have you ever been torn between two places to live, or different cars to buy, or which college to attend? The anguish you can endure making any one of these decisions can drive you out of your gourd, can’t it?

My wife had a friend who was torn between proposals from two different suitors. When she came over to hash out the differences between the two men, I eventually had to excuse myself and let the two women juggle the pros and cons of each potential husbands.  If Freud was correct that the inability to tolerate ambiguity is neurosis, I guess I was feeling too neurotic to hang in for the verdict. Either that or there was a game on.

But for many of us one of the toughest quandaries, and certainly one with ramifications for the future almost on a scale with whom you marry, is your investment decision process. Should you go with a value stock, a momentum stock, or one that, over the years, has paid out a generous dividend? And perhaps most vexing of all, what are you missing?

Should you invest based on facts and figures, or go with your gut feeling? Don’t kid yourself; professional investors struggle with the same ambivalence. Multibillionaire George Soros claims he’s often relied on pure “animal instinct” to make an investment decision. Meanwhile his son has revealed that often the elder Soros is guided by nothing more than a persistent back pain he takes as a signal he’s made a mistake.

According to the relatively new science of neuroeconomics, alternatively called behavior economics, we put too much “untested faith” in ourselves when making investment decisions. Indeed, in a survey over eighty percent answered “yes” to the question, “You are better than most people at identifying market trends, or picking winning investments.”

But if you think a totally rational approach to investing is usually more reliable than the Soros back-ache test, you’ve got another think coming. In his provocative 2007 book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, financial journalist Jason Zweig dispels many of the cherished myths about what it takes to be a successful investor.

For instance, if you think smarter people make more money, Zweig reminds readers how the great Sir Isaac Newton was wiped out in a stock market crash in 1720. Apparently he was less familiar with certain types of gravity.

Oh, and do you think the more work you put into investing, the more money you’ll make? Not according to Zweig, who claims, “[P]rofessional investors on average do not outperform amateurs.”

It’s all a matter of understanding who you are as an investor and how the human brain works. Zweig reports that the science of neuroeconomics shows, “A monetary loss or gain is not just a financial or psychological outcome, but a biological change that has profound physical effects on the brain and body….” This same science shows that financial losses are processed in the same part of the brain that forces us to respond to mortal danger.  No wonder you’re stressed; it really does feel like a Mack truck headed right at you.

For sure, Zweig’s book offers many pearls of wisdom, like how to read an annual proxy statement, and even the Chairman’s letter to the stockholders in the annual report “with your emotional eyes open.” And I have little doubt if you read this book, and other popular works on applied neureconomics, you’ll become a cannier investor.

But it’s also worth considering that maybe people see themselves as taking an “intelligent” approach are simply trying to out-think immutable facts. The chances of getting rich quick are small, and the tried-and-true path of plodding along, keeping at it, and particularly, making sure you’re genuinely diversified, is the real way to end up richer than you started.  But true diversification, the kind that protects you from market upheavals and sudden downturns, isn’t about having both stocks and bonds.  Paper tied to the market is paper tied to the market.

Ensuring your paper is buttressed by tangible assets that have inherent value lets you protect your portfolio both from outside disasters and from rational and irrational mistakes. Because it’s inversely correlated to both stocks and the dollar, gold is where investors, including George Soros, turn to recover from their own impulsiveness as well as the irrational moves of markets and market makers (and breakers).