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.
To read Part 1 of this interview, click here.
Bill Mann: In advising for the Fool newsletters, I get this question from time to time from folks: "How do you control your emotions?" I am not emotion-free; nobody is. It is recognizing them and adapting to them.
Jason Zweig: Right, and this is a very tricky thing, Bill. Warren Buffett has actually said that if all you do is understand the emotional framework that Ben Graham gives you, just doing that alone will make you a much better investor.
Mann: You mean it's not better discounted-cash-flow models that makes Berkshire Hathaway
Zweig: The thing is, it is so hard to do. It is not about turning your emotions off; it is about turning them inside out. There is that wonderful famous quote about Charlie Munger at a dinner party, and this woman turns to him and says, "Mr. Munger, you know you are a great investor. You have become a billionaire with your investment ideas. What is your secret?" Charlie, as only Charlie can, sort of spits out three words only and then goes back to his food. He said, "I am rational." And the conversation is over.
If only it were that easy -- and for Charlie, it probably is -- but Charlie Munger is a freak of nature, and none of us should aspire to be a bunch of mini-Mungers; it is not going to work. Merely turning your emotions inside out is not a practical prescription. It is like saying to a depressed person, "Get over it."
Mann: Yeah, be happy.
Zweig: Be happy. Smile, damn it. You can't just say to somebody who is miserable because they lost 20% in August, "Well don't worry about it; it is OK." So what is the practical solution? How do you get around this?
In the book, I talk about this idea of keeping an emotional registry. The reason we don't learn from our mistakes is because we have this inner con man who continually lies to us about how good we are, what we did way back when, about what we will do in the future. So how do you solve that?
What you do is in real time, you keep a real diary. It doesn't have to be expansive, but it is easy to imagine what it would look like. In July of this year, when the Dow was at 14,000, if each day you just wrote down how you felt about your portfolio, what would people have said when the Dow was at 14,000, on its way to 15,000 (according to all the experts)? You would have written down, "I feel good. This is great. Everything I knew would happen has happened," or "I knew that Amalgamated Widgets would go up, and gosh darn it, it did." Then a few weeks later, what are you writing in your journal? About how miserable you are and how stupid you feel.
Mann: "I should sell it all and wait for it to finish going down."
Zweig: Right, and maybe you are actually acting on your panic, and your fear, and your anger. Chances are, a lot of what you are feeling is anger at listening to the experts or believing your own BS. And in September, when the market was treading water in quicksand, maybe you go back and you look purely at the emotional component of your little diary, and you try to learn from your past emotions. You say "Well wait a minute. I was happy when I should have been sad. I was sad when I should have been happy, because I could have been buying more at a lower price. Maybe I need to learn that my euphoria and my misery always come at the opposite times."
Well, the best way to do it is to take it out of my decision making, because obviously, despite what Malcolm Gladwell might have us believe, my emotional intuition is not a good guide when I am investing. Because when I am happy is when I should be wary, and when I am upset is when I should be pleased, so therefore, I have to stop reacting on the basis of these emotions, because they do not give me a good guide to what I should be doing. And so, how would I do that? Well, with a plan. I have to automate things. I have to have checklists, and I have to actually make a vow or a pledge or a commitment that I am never going to make an investing decision in response to what other people are doing.
Mann: A subscriber to Hidden Gems, one of our services, came in and said, "OK, I am going to make this pledge. I have bought my stocks. I am not going to quote them for a year." And so he went through the process, updating us, and literally, his updates would be things like, "I went out and played baseball with my son and I heard this about X company and that sounds pretty good, but I don't know;" and I must say, I felt jealous of this guy. (Laughs.)
Zweig: Well, you know, just getting back to what we were talking about before with cue controls. How do successful addicts conquer their addictions? The worse imaginable thing an alcoholic can do is to say, "Well, it has been three-and-a-half years since I had a drink. Of course I can walk into that bar."
Mann: Yeah, no problem.
Zweig: "Because I have whipped it. There is no way I am going to take a drink." And it is all over. The same thing is true for any addiction, and getting back to that brain scan you asked about earlier, when you look at the brain of somebody who has had repeated scores in an investing game, it is indistinguishable from the brain of someone who is addicted to cocaine or morphine. The only way you can break the addiction is to get away from the cues that remind you of the substance. In this case, the substance is stocks.
Mann: I am just thinking that I guess all this means that we just need to shut down. (Laughs.)
Zweig: No, that is not at all what I mean; quite the opposite. There are so many ways that information is useful to people, and community is useful to people, because being able to find a community of like-minded people is so important to the extent that sites like The Motley Fool do that for people; it gives them a sense of belonging. And that is my big criticism of the fund industry. After all these years, they still don't treat their investors like family; they treat them like customers, and they treat them like airline customers, frankly. They don't even give them frequent flyer miles, but basically, they throw them a few peanuts and scream at them at the check-in counter, and they kick them in the pants on the way out and lose their luggage.
Investors are very patient people. You think about what a profoundly weird transaction this is. You write a check. You mail it off to a P.O. Box in Kansas City or Boston, to be cashed by people you will never meet, to be put into stocks you may not be familiar with to get a little update four times a year. No personal thank-you. No acquaintance with the people who are running their money. What a lonely experience it is to invest in a conventional mutual fund.
So any investment meeting ground that enables people to come together are just incredibly helpful, whether it is like the Vanguard Diehards, or The Fool, or whatever it is, it gives people a place to go where they can meet others like themselves, and learning to be patient, finding out it is OK that you don't have to trade like a maniac and that there is a difference between trading and investing, and that other people have been doing it, and they can help you. That is so important.
Mann: We make live recommendations of stocks, which means that we have ample opportunity to make mistakes and have to say, "Wow, that was idiotic. How could you have not seen that X, Y, and Z were going to happen?"
As stock pickers and as investors, we know that things are going to go wrong. One of the really interesting things to me is how in so many cases, I struggle with fighting the perception that the outcome that happened, that that was the only outcome possible.
Zweig: Right. Yeah, well hindsight bias, as it is technically called, is one of the real problems in the way the brain is designed. If you think about all the human endeavors there are out there, investing is a really bad one for hindsight bias, because you get continual feedback on everything you do. The first thing that is easy to forget is that the feedback you get from the stock market is lousy.
Mann: Good outcomes from bad decisions, for example.
Zweig: What psychologists talk about is the conditions for learning, and to learn the right things in the right way, you need very specific feedback. It needs to be quick, and it needs to be unambiguous. Say you are learning how to knit. Well, Aunt Mildred is sitting next to you, and as soon as you drop a stitch, she says, "You dropped a stitch." She doesn't ... she doesn't say, "Twenty-five minutes ago, you dropped a stitch." Nor did she say, "You might have dropped a stitch." She is watching you.
Mann: And a year and a half later, it turns out that you actually didn't drop the stitch; you had gotten it exactly right.
Zweig: And that is the other problem. The other problem is that the feedback in the stock market is so variable that it almost doesn't even qualify as feedback. You could be right in your first minute of owning a stock and then wrong for the rest of your life, and vice versa. So, the feedback is terrible, but it is so in-your-face that it is impossible to ignore it. The only way you can cure hindsight bias is by keeping very good records. The other trick is you have to keep your records instantaneously, because if you wait five minutes to give your rationale, your rationale will change based on what happened since the action you took.
Mann: You get hindsight bias on something that is supposed to be in real time.
Zweig: Yup. My clock says it is 12:48 p.m. right now, so if I buy a stock at this moment, and I wait until 12:53 to write down why I bought it, my judgment about why I bought it will be shaped by what happened in the ensuing five minutes.
Mann: Yeah, you have already gotten feedback. How'd you do?
Zweig: Once the feedback comes in, it overwrites everything that was there beforehand, so I think the best suggestion for people is you write down not just why you bought the stock, and you need to be very specific about that, but you probably want to write maybe three reasons, not more, but probably not fewer, either. You have to do it before you do the trade, and then you want to be very specific about what you think is going to happen. "I think there is a 70% chance that this stock will double in the next year, because _________. " Then you give your three reasons, none of which can be about the stock. They all have to be about the business.
Mann: I think that is exactly right. I think it is a great habit that too few people have. Putting things down on paper gives you a very easy way to go back and say, "Well look, none of the things that were reasons that I bought this stock happened, so it is OK to let go."
Zweig: It is so important, because in the short run, you get rewarded for doing the right thing for the wrong reason, and that is why it is so hard to distinguish luck from skill. Most professional money managers, if they just stay at it long enough, they will beat the market one year just because of randomness.
Mann: That was the skill year, right? (Laughs.)
Zweig: In their minds, it definitely was the skill year, but the thing is, in the long run, you can only get rewarded for doing the right thing for the right reason. If you don't know what your reason was, you will lie to yourself about what it was. The only way to avoid that is to write it down beforehand and keep the record. If a stock triples for reasons you never anticipated, you are not a genius. You are lucky. That is not bad. I mean, enjoy it, but don't convince yourself that you knew what you were doing.
Mann: Because you are almost guaranteed to give it back trying to do the same exact thing.
Zweig: And there is a lot you can learn from being right for the wrong reasons. Then study the stock and say, "Wait a minute. Why did it go up?" Then try to apply that and integrate it with the theory that you had, and you may come up with a very good theory that could make you a lot of money in the future.
Mann: Yeah, I think that is right. Well, Jason, I think Your Money & Your Brain is a brilliant book, and I hope every investor reads it.
Zweig: Thank you, Bill. Thank you. You know, this whole business about unconscious emotion is really the key. I'll tell you one last little story: I was giving a talk at a money management firm -- actually in Edinburgh, Scotland -- this summer about the book. I put up a slide about unconscious bias. You might remember at the beginning of the book, I tell this anecdote about this doctor who bought a stock because the stock ticker was the same as his initials.
Zweig: This is called implicit egotism by social psychologists. I put up a slide about all the ways this phenomenon shows up in life. For example, people are 65% more likely to marry somebody with their own initials. Women named Georgia are twice as likely to live in the state of Georgia, as you would expect, by random chance.
Then another classic one is that people named Dennis and Denise are something like 70% more likely to become dentists than you would expect by random chance.
Mann: I know that I am rooting for the company MannKind to do very well.
Zweig: So, I put up this slide with all these examples, and then I say to all the analysts and portfolio mangers in the room, 50, 70 people, "You should take the brightest, young, most ambitious, curious analyst in your firm. Give him these seven research papers to read about this psychological phenomenon, and then have him or her go through all your portfolios looking for unconscious bias." Bill, I never looked at such a stone-faced crowd. Half of them were rolling their eyes.
Zweig: They were just like, "You have got to be kidding me."
Mann: We are professionals here.
Zweig: "There is no way that I would ever buy a stock because its ticker matches my initials. That is the stupidest thing I have ever heard." I also told them that anyone with brown eyes is more likely to buy UPS
It turned out that the firm they are most overweight in the entire continent of Latin America has the same initials as their firm.
Zweig: And he turned to me and he said, "For this alone, I am glad you came, because this is something I wouldn't have realized in 10 years, but now I am very concerned that it is a great company. I am still glad we own it. We didn't buy it because we liked the ticker. We bought it because we love the company, but clearly, we are very overweight because we do like the ticker. And what really worries me is how are we going to sell it when the time comes?" He said, "Thank you for coming, because if I hadn't heard you, none of this would have ever occurred to me, and now I know we have a problem. When the day comes that we do feel we may need to sell it, now we really are going to give it a second look and make sure we are approaching it logically."
So, that was such a relief to me, because this kind of stuff is so out there, and people are so resistant to it, that I thought maybe I am just making this up. But hearing him say that really convinced me.
Mann: You know, there is some reason out there that companies have cute ticker names.
Zweig: Yeah, and did you see the new agro-business ETF with the ticker MOO?
Mann: Oh, come on.
Zweig: By the way, there is very good research on that. Companies with cute tickers do outperform, particularly in the short run, when you first start trading, and it is for exactly this reason. It is because it is familiar. It is easy. It basically goes straight to the hippocampus in the brain. You say "Well, I have heard of this company my whole life. It must be good."
Mann: Yeah, yeah.
Zweig: MOO is the ticker, you know? I like moo. I drink moo every morning. I give moo to my kids.
Mann: I am down with moo.
Zweig: I am there; I am there. Give me some moo. Like Starbucks
Mann: Yeah, I am going to go out and buy some now.
Zweig: Yeah, right; me too.
Mann: I have talked myself into it. It is bound to be a good idea.
Mann: Jason, it has been a complete pleasure.
Zweig: Thanks, Bill.
If you missed Part 1 of Bill's interview with Jason Zweig, click here.