In late September, Motley Fool Hidden Gems and Global Gains advisor Bill Mann sat down with renowned financial journalist Jason Zweig. Zweig's new financial book, Your Money and Your Brain, tackles the fascinating topic of neurofinance, the ways that your brain can trick you and cost you money. We hope you find this interview as engrossing as we do.
Bill Mann: One of the criticisms that I have of the financial books in general is that it seems to me like every new title is a rewriting of Graham or Buffett or Jesse Livermore or Soros ....
Jason Zweig: Or Jim Cramer.
Mann: Exactly. It is not something I say lightly, but this is the first financial book that I have read in years that really covers new ground. The topic is "neurofinance," which has far too many syllables to seem like it is going to be interesting, but you've written a fascinating book.
Zweig: Thank you, Bill. You know, I guess people say, "So, is your book good?" How do you answer that if you are not an egomaniac? What I say is "Well, I know that the raw material is fascinating; the subject matter is incredibly interesting. You will have to decide whether the book is interesting, but certainly what the book is about is very interesting."
Mann: What made you wander into the field of neuroeconomics?
Zweig: About 10 years ago, I was sitting at home one evening, reading The Journal of Financial Economics while my wife was correcting fifth-grade history papers. She sort of looked up at me very quizzically, and she squinted until she could read the title, and then she said, "Is that interesting?" I paused for the longest time, and I finally put it down, and I said, "No."
Mann: (Laughing.) It ought to be.
Zweig: I got up, and I don't know what I did; I took a shower or something. The next day, I went on a business trip, and I realized in the airport I didn't have anything good to read, and I wandered into the airport bookstore, and I said, "You know, gosh darn it, I am going to learn a lesson from last night. I am going to find something to read that is nothing like what I normally read." My eyes fell on Scientific American, and I said "You know, I loved this magazine when I was in high school and college," and I just grabbed it and bought it.
I walked away from the bookstore and I opened it to this beautiful full-color image of a human brain. About two-thirds of the way through this article was a passage explaining that people who have had their brains surgically snipped in half as a radical treatment for incurable epilepsy calculate probability completely differently from people with intact brains. I stopped in the middle of the airport walkway hallway, and I grabbed my red pen, and I circled it, and I just said to myself, "Bingo."
It actually took me over a year, because the guy who [had] written the study hadn't published it yet, and when I got in touch with him, he didn't want to talk about it. He said, "Call me in a year," which I did. He insisted it had no utility, no meaning, no purpose for anybody interested in investing. I thought "This is the coolest stuff I have ever seen." And that was that.
Mann: So, basically, the premise of the book is that people's brains are set up to trap them in certain ways, when they're thinking about finance and investing. They're too confident that they [should] go for the big score, when everything that we know about investing is that slow and steady wins the race. What is it about the brain that makes it so attractive for us to go after things that really aren't that good for us?
Zweig: Well, Bill, I think it goes back to just understanding how we got our brains. Our brains were designed to give us the correct answers to a very simple but very different set of questions. Our brains were not designed to do calculations of option-adjusted spreads and all the other complicated formulas that certainly the professional investors use and that a lot of individual investors use, too.
Our brains were designed to get us out of the cave and get us home safely at night and keep us alive long enough so that we could reproduce, because the lifespan in the formative years of the human species was very short. If you were lucky, you lived to the age of 30 or 35. So, the human brain is not particularly good at planning decades ahead, which is why so many people have a hard time saving.
Living in small groups, as humans did many, many millennia ago, the person who could reliably identify the big score was the one who would become the leader of the group and would be looked up to by everybody else in the group, for good reason. If you knew where you were most likely to be able to kill a mammoth or whatever big game your clan might be hunting, you became the alpha hunter. You were most likely male. We do know that even today, men take more risks as investors, they are much more easily seduced by a low probability of a high payoff than women, and all of this goes back to primitive mankind, when it paid sometimes to take a really big gamble; when the tribe was running low on food, you couldn't play it safe; you had to take a risk, or everyone would die.
Mann: The gamble was the safe move at that point.
Zweig: Exactly. It is very easy to forget when you are a stock or a mutual fund investor, as Warren Buffett likes to say, that you don't have to swing at every pitch. Because the way the brain is designed, basically, any pitch that is anywhere near the plate is going to look like a fat pitch. To wait for that perfect pitch takes an enormous amount of discipline and practice, which is why you and I, if we were facing a professional baseball pitcher, would strike out. We haven't had that practice, and we haven't been able to develop that discipline, no matter how many games of softball we have played.
Mann: I would swing at the first three pitches just to make it stop. (Laughs.)
Zweig: Yeah, me, too. And that is not to say that as investors, we individuals are at a disadvantage against the professionals, because I don't actually think that is true, and I know you don't, either.
Mann: No.
Zweig: I think individuals, if they define the rules of the game properly, can be much more restrained about which pitches they swing at than professionals can. Professionals are paid to swing, because what do fans in the cheap seats scream at a baseball game? They scream, "Swing, you bum!" If you are a professional money manager standing at the plate, you can't take an infinite number of balls; you have got to swing, because you are being paid to perform, and you are being paid to perform now. But you and I can wait, only if we understand the limitations of how our mind works. So, that is why I think learning a little about neuroeconomics is important.
Mann: One of the most interesting things that I found in the book was a section where you started talking about controlling as opposed to broadening the number of inputs, and the type of inputs, that you get when you are making your decision, something that you call "cue controlling." But when you watch financial news, for example, they have added sound effects when they bring up a chart, or they have blinking lights and things like that. Why is that such a negative for investors?
Zweig: Oh my goodness, is it ever. To me, you have put your finger on what probably is the single biggest obstacle that individuals face in the attempt to get good investing results. Think back, Bill, to when our parents were investing. I mean, I don't know about your folks, but my dad was a pretty typical sort of middle-class investor in the '60s and '70s. He owned a handful of stocks ...
Mann: And looked them up in the paper the next day to see how they did.
Zweig: Right. He made a couple of trades a year, really. I grew up on a farm in northern New York State. Unless he subscribed to The Wall Street Journal -- which he was too cheap to do -- there was actually no way to get the daily closing price, except to call the broker, which he was too busy to do. We had to wait for the Saturday newspaper, because the local paper didn't have stock prices in it, covering the whole market. So, once a week, if he remembered, my dad would check on his portfolio. He didn't own any mutual funds, and a lot of weeks, he would forget.
You contrast that state of mind with what people face today. Your iPhone, your cell phone, your computer monitor, your screen saver, basically every high-tech device that plugs into your body or sits in front of your face is bombarding you with continuous updates of price, and it is incredible how continuous they are. You take a liquid stock like Intel
Mann: Because it is looking for meaning for all of it.
Zweig: Because as soon as you see two picks in a row going in the same direction, your brain is designed to automatically interpret that as a trend. Two upticks, it is going up; two downticks, it is going down. When that is combined with these sort of fundamental sensory stimuli, like the clanging bell and the color red or the color green, it makes you crazy.
Mann: Let's at least hope for a little green.
Zweig: A little green would be good. When those sensory impressions are laid over this continuous updating, it really -- it makes you crazy. The speed at which the human brain can respond to what appears to be a threat is incredible. Within 120 milliseconds -- an eighth of a second, or a third of the time it takes you to blink your eyes -- [of] a flashing red color, an arrow pointing down, a picture of a trader screaming on the floor of the stock exchange, your pulse goes up, your breathing becomes faster. Your blood pressure rises. Your muscles tense. Your face forms a frown, and all of these things can happen without you being aware of it.
I think the biggest discovery to come out of neuroeconomics is the way it has deepened our understanding of what psychologists call unconscious emotion. You can be in the grip of very powerful feelings and have no concept that you are actually feeling them. It is so hard to convince people of this, because on the face of it, it sounds impossible.
Mann: Right, a feeling is a feeling.
Zweig: Well, how could I be feeling it if I don't feel it? The answer is, your body feels it. The best analogy I can use to help people understand it is to think about when you are driving down the road, and all of a sudden, a little kid on a tricycle shoots out in front of you. You know what to do; you don't sit there thinking, "Should I turn left or right? Should I accelerate or brake?" You just do it, instantaneously. As soon as it is over, and God willing, nothing happened to either you or the kid, your heart is hammering, your eyes feel like saucers, and you can't believe what just happened to you, you are so upset.
Well, what you can't know is that you were upset in the very split second you first saw the kid, and what you are feeling after the car comes to the stop is actually the aftermath of being upset. Your body has actually come way down from where you were when you swerved and slammed on the brakes. That is when your feeling is most intense, and it is only after the fact that you realize you feel something, but what you feel now is nothing compared to what you were feeling at the time. You just weren't aware of it, because you were focused on swerving and slamming on the brakes.
Mann: And Malcolm Gladwell says that all these are good things.
Zweig: Yes, and they are very good things when a kid on a tricycle pulls out in front of you, or if you are on the front lines in Iraq, and there is an incoming mortar. It is really bad when you are watching CNBC, or you are clicking on E*Trade, and all you see is red, because red has an intense effect on an investor, as it has on a bull. It doesn't make you mad; it makes you scared.
Mann: Agitated.
Zweig: That is a huge stump speech and a very long answer to your question, but I think what I take away from that sort of research is, it is so important for investors to realize that technology is not just your friend. I mean, you have been doing this for a long time, too. You remember the days in the late '90s when people like Jim Cramer and any number of others were online saying "Now that you have the same tools as the pros have always had, you can beat them at their own game."
Mann: Yeah, Peter Bernstein said not that long ago that he didn't feel like the access to technology has made people more thoughtful investors.
Zweig: Right. To me, the bottom line from all of what we have just been talking about is, it is so important to realize that technology is a tool; it is only a tool. It doesn't empower you. That is like saying nuclear power is great. Well, in the hands of a radiologist who is treating a tumor, it is. In the hands of a madman, it is not. Being able to update your portfolio can be very useful and helpful if you are a patient long-term investor, but if you are a maniac, it just enables you to commit financial suicide faster.
Getting back to cue control, it is very important to design your environment so that you are surrounded by things that echo your own personal goal, so that if you want to have a long-term perspective, you have to make sure you are not clicking on Yahoo! Finance 10 times a day, or that if you are going on The Motley Fool 10 times a day, you are chatting with your friends, not updating the price of your portfolio. Because it is that constant updating that will doom you to constantly perceive things that aren't there and to take action.
Mann: You know, right up the road from you at Columbia University, some very influential research came out about 50 years ago regarding the efficiency of markets, and everything that has come after that has had the same base assumption, and that is that the market and all its participants are rational. But what you are saying to me is not only are the people who just take stock picks based on what Uncle Earl says not rational, but most every participant has the same problem.
Zweig: Oh yeah, there is no doubt in my mind that neuroeconomics has lessons that are at least as relevant for professionals as they are for so-called amateurs.
Mann: I am sure -- overconfidence being at the top of the list.
Zweig: That is correct. You know as well as I do, there is really no statistical evidence that professionals are any better at investing than amateurs. The puzzling thing is, you would think that wouldn't be true before costs. Logic would suggest, well, professionals probably are better than an amateur; that is why they are called "professionals." They are trained, they have lots of resources the rest of us don't, so maybe it is just [because] they charge more for their services that the net result is not better. But even before costs, it is hard to make the case that professionals have an advantage.
My takeaway from all of this is, we need a better definition of what it means to be rational. I think that the real problem is not that we are all irrational; it is that we have been led to believe in a definition of rationality that isn't realistic. The main reason it is not realistic is because it doesn't account for emotion. That is why I organized the book around these themes of emotions that every investor goes through.
The thought that a professional investor who has beaten the market would not be influenced by his own track record and then go out and either take too much risk, because he thinks he is God, or cut back on the risk he is taking, because he is afraid he will lose his market-beating returns, is ridiculous. He is not going to be the same investor after beating the market that he was before, and he is not going to have the same attitude toward his stock picks. Any financial theory that ignores pride, let alone ego, and pretends that there is no such thing as overconfidence, is lacking.
Mann: It is interesting to think that in almost every discipline, there is the feeling that you can get better with practice. But there isn't a general level of evidence that that is true when it comes to financial analysis.
Zweig: Yeah, and I think it is because even professionals don't understand when practice helps and when it doesn't. Just getting back to baseball: If you are, say, Alfonso Soriano, and you are an infielder, and every day, you take 300 or 400 ground balls in practice, and you throw to first, second, third base all day long, you are really going to get good.
The reason you get a competitive advantage is because it is not a zero-sum game. Soriano, being a great infielder, doesn't become great by making someone else worse. But in investing, each trade is a zero-sum game. I can't make more money off a stock pick without the other guy losing. He knows that, too, so he is not going to sell it to me unless he thinks it is not worth owning. So, I am ignoring his intuition and I am ignoring what he already knows about the stock when I conclude that I know more than he does, because unless I ask him, and unless he tells me the truth, I have no way of knowing that.
It doesn't matter how many times I practice, I am still going to be always underestimating how much he knows, and that puts a ceiling on the ability of practice to improve my performance.
Mann: It makes the term "more buyers than sellers" seem like one of the most stupid things that has ever been derived.
Zweig: It is, because there is always one of each. The difference is in the emotions. Maybe the best way to think about successful investing -- and I never thought of this until you put the question in that great way -- is that what is really happening in a successful trade is one party is going long on optimism and the other party is going long on pessimism. Or you could say one party is shorting greed, and the other is shorting fear.
One of the emotional trades will be right, and the other will be wrong, so when people say there are more buyers than sellers, that is not what they mean; what they mean is that one side was more enthusiastic about one emotion than the other.
Mann: We could come up with a chart about this and put some bells and whistles on it, and it would probably be very useful for people.
Zweig: Yeah, and it would basically explain everything you need to know.
Mann: I am glad we have solved all problems.
Zweig: There is an interesting lesson in this, which is: If you talk to the great investors, to Bill Miller, if you talk to Chris Davis, Mason Hawkins, this is exactly what they talk about. I spoke with Mason on Aug. 29, and when he picked up the phone, and I said, "How are you?" ... he said, "I'm great." And he sounded like Tony the Tiger. That was after the worst week in quite some time for most people, and at the end of a really awful month, and he sounded as if he just found $500 on the sidewalk.
Mann: You have enough information out there to know that he didn't necessarily do that well through the month.
Zweig: Right. And it is interesting what he said to me: "I think or I hope we are building the foundation of value for the next 10 years." Chris Davis once said to me, "I have trained myself to become more enthusiastic when I feel afraid." He said, "You have to understand that the perception of risk and the presence of risk are opposite things." That is what this is really all about.
