Investing Like a Psychopath

Source: Recite.

What makes a good investor?

People who are calm. People who take a long-term view. And, according to one study, people with brain damage.

In 2005, a team of researchers from Stanford, Carnegie Mellon, and the University of Iowa gave a group of participants $20 each. They were then made an offer: You can flip a coin up to 20 times. If you lose the coin toss, you owe $1. If you win, you get $2.50.

Everyone in this situation should make as many tosses as possible, since there's a 50/50 chance of accurately guessing a coin toss, and the reward for winning is far larger than the penalty of losing.

But the researchers found only one group of participants willing to make large numbers of tosses: Those with a lesion in the area of their brains that controls emotion.

Participants with normal brains threw in the towel after flipping a few losses in a row. People don't like losing money, and even if you know the odds are in your favor, a couple losses will turn you off.

But those whose brains suppressed emotions kept on betting, regardless of past losses. Not surprising, given the odds and payoffs of the coin-toss game, they ended up with more money.

One of the co-authors of the study called these coin-flippers "functional psychopaths," since their damaged brains prevented them from being affected by emotions. The non-psychopaths with normal brains remembered how losing felt and became twice bitten, once shy. Their memories blocked rational behavior. 

Your money and your memory 
Next to losing sight and motion, surveys show losing your memory is one of the most frightening things people contemplate. But we rarely think about how our memories hurt us. As investors, they often do. 

We're more likely to remember negative, emotional events than ordinary or positive ones, especially in the short run. That's how it should be: You want to learn to avoid bad things that happened in the past. But it plays a dirty trick on us: "People tend to assess the relative importance of issues by the ease with which they are retrieved from memory" psychologist Daniel Kahneman writes in his book, Thinking Fast and Slow. Since we give more weight to negative memories, we spend more effort trying to avoid bad experiences from happening again than we do trying to trying to benefit from positive ones, even if the positive ones offer huge upside. It's called loss aversion, and it's the flaw the normal-brain coin-flippers suffered from.

Think about this from the standpoint of an investor. The market falls 50% in 2008 and early 2009. That hurts. Then it rallies 130% over the next few years, recouping all of your losses and then some. This feels OK, but not nearly good enough to ease the shock you felt from the 50% crash, which was emotional and memorable. You remember the crash much more vividly than the ensuing rally, and you change your portfolio to make sure you never suffer through a crash again. You buy bonds, hold a lot of cash, and swear off stocks for good. We've seen quite a bit of this behavior over the last few years. And we know it comes at the expense of long-term performance.

Worse, our memories of emotional experiences tend to get rearranged and distorted, so much so that some of what we remember never actually occurred. In his book Omaha Beach, Joseph Balkoski writes that, "one firm lesson that serious World War II researchers have learned is that the reliability of human memory varies drastically from one veteran to the next." Time, Balkoski writes, "can play subtle tricks on the mind, and the historian's thorniest problem is to separate those rare fully substantiated accounts from the more typical yarns that time has established."

Veterans recalled experiences, both positive and negative, that historians could verify were "incomplete, if not inaccurate." Some think Hilary Clinton did this when she recalled coming under sniper fire during a 1996 trip to Bosnia -- an account she later recanted. Clinton may have been completely honest when recalling the experience. Her brain may have just remembered the event different from how it actually occurred. Kahneman calls this the "Experiencing Self" and the "Remembering Self." They are often two completely different people.

Delusions of wealth 
Investors suffer from this flaw, too. Martin Weber and Markus Glaser of the University of Manheim showed that investors have no idea how they've actually performed, and those who performed the worst -- those who lost the most money -- were the worst at recalling their actual performance. What we remember happening often has no connection to what actually happened. "There is just a lot of self-delusion that goes on when people evaluate their [investing] performance" Kahneman told me earlier this year. "Our memory just doesn't correspond to the facts."

So, what are you supposed to do about it?

One of the best ways to fight your poor memories as investors is to keep a journal. Write down exactly how you feel whenever you buy or sell a stock. Write down the reason you're making the decision. Write down how confident you are in it being right. Be honest with it. 

Any time you're tempted to drift away from your typical investment plan, consult that journal. Go back and see how you felt about the market in the past. You'll likely discover how faulty your memory can be. I often write about how wonderful market crashes are to long-term investors looking for buying opportunities. I pretend like I can't wait for the next one to arrive. But when I go back and see what I wrote in 2008, I can't help but notice how worried and nervous I was. I worried the banking system would collapse. I worried about a lost decade. And when I review what I did with my money back then, I can only conclude that I was much more scared than I now think I was. It's far easier to say, "I'll be greedy when others are fearful" than it is to actually do it.

That could be setting me up for all kinds of problems. If I think I'll be braver during the next crash than I actually will be, maybe I'm holding too much cash in my portfolio. Maybe I should be fully invested instead of waiting around for cheaper prices. Maybe my asset allocation is all wrong. These are serious questions I need to consider. 

Keeping a record about your investing emotions is only way to fight your bad memory and the dangerous path it can set you on. It might be the only way to invest like a psychopath. 

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 

No Pitch


Read/Post Comments (28) | Recommend This Article (105)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 15, 2013, at 5:03 PM, Schneidku40 wrote:

    It probably sounds bad but the title and first four sentences made me laugh.

  • Report this Comment On October 15, 2013, at 7:29 PM, lovepeace wrote:

    Conquering your emotions is the biggest secret to successful investing. Have a plan for all your investments, write it down if you have to, and stick to the plan! Great article.

  • Report this Comment On October 16, 2013, at 12:42 PM, daveandrae wrote:

    What makes a good investor?

    Patience.

    In 1962 the average holding period for a stock listed on the NYSE was eight years. Today, it is less than seven months...and getting worse.

  • Report this Comment On October 16, 2013, at 2:11 PM, KBOKSOFT wrote:

    Another great article.

    I have a friend who trades on emotion. He loses a lot.

    I suggested making an index card for each stock he's watching including: ticker, description, target buy price, max portfolio composition, 1 year price target, 5 year price target, 10 year price target, and UNDER WHAT CIRCUMSTANCES IT SHOULD BE SOLD.

    Before selling the position, look at the card. Does it say "Sell if Cramer no longer likes it"? Does it say "Sell if the price drops 10%"? Does it say "Sell on a 8% price pop to 'take profits'"? No? Then don't sell.

    I'm surprised at how many times he can't even get the description on the card, because he's not sure what the company does...

    I say strategize with your heart and mind, but make your tactical investing decisions like a robot.

  • Report this Comment On October 16, 2013, at 7:16 PM, veritasvincit wrote:

    Another way to think about successful emotional investing is to invert your interpretation of what constitutes 'good' and 'bad' news.

    I now consider monster declines in the market, such as we saw 5 years ago as marvelous news for investors. What an incredible buying opportunity for quality US equities it was! That was 'good' news for those holding cash.

    When we see stocks soaring even further, and I believe they will, as the typical emotional retail investors finally begin to buy stocks, we'll see them abandon other asset classes such as bonds, even though interest rates will undoubtedly have climbed. More 'good' news, as perhaps it's probably time to sell some equities and purchase those bonds at cheap prices, so you're holding them during the next time equities swoon, while still earning respectable returns.

    In other words, there's a lot of good news out there, if you simply change your definition of it.

    Only true psychopaths would wish for deep recessions, but there's no crime in purchasing good investments when there's a fire sale. The investing public would do well to apply their thirst for discounts on retail goods to their investing practices. Never pay full price!

  • Report this Comment On October 16, 2013, at 7:51 PM, sagitarius84 wrote:

    Morgan,

    You have some of the best articles not only on Fool, but on the web. I really like how you always manage to refute "common foolishness" in the crowds.

    Keep it up man!

  • Report this Comment On October 17, 2013, at 2:12 AM, FooLawson wrote:

    Awesome article as always Morgan,

    I have started my journal today... Now onwards to my psychopathic ways!

  • Report this Comment On October 17, 2013, at 5:28 AM, smartlyfoolish wrote:

    good read Morgan.

    Emotions makes you do and logic justifies the do, opposite not true

    so it is with investing

  • Report this Comment On October 17, 2013, at 6:26 AM, enginear wrote:

    My journal is old and dog eared, but doesn't include the touchy feely part... it does explain why I bought/sold and that is essentially the same (or a pretty good reminder if not).

    In fact, it takes a long time to become, as one comment said, patient. I sat on my hands from 2008 through 2010, and that was a terrible reaction in my view now (hindsight being as it is, 20/20), but it was a fair to middling reaction. It took me 26 years of investing to reach that level of patience.

    With luck and persistence, by the time I'm ready to be put in the ground, I'll be a 'good' investor (will have been?). All you youngsters need to remember that money is of, and for this world, and whereas, I encourage you to do well with it, don't go crazy... enjoy your life. Retirement comes sooner than you think, and do we really need two or three trips to Hawaii (or the Himalayas?!) each year? (when you get tired so easily - naps are quite inexpensive, and very enjoyable!).

    I know the CFA's association hates to see this come forward, but years of frugality taught me... well, to be frugal. It doesn't disappear instantly, and I suspect a few Fools are a bit frugal.

  • Report this Comment On October 17, 2013, at 7:59 AM, mikecart1 wrote:

    The best poker players in the world are the ones that don't see the chips as money but as tools to "beat the game".

    :)

  • Report this Comment On October 17, 2013, at 9:33 AM, JadedFoolalex wrote:

    Do yourself a favor and buy an "Andex" chart. It shows the results of investing $100.00 in the six best investments over the past 80 or 90 or 100 years. Guess what. THE best investment is ALWAYS 100% stocks held for the longest time period!!! The market always goes higher. If that isn't incentive enough to stay invested in stocks, I don't know what is!!!

  • Report this Comment On October 17, 2013, at 11:30 AM, ziq wrote:

    Wouldn't people who understand math do as well in that situation? Your probability of a net loss after 20 tosses of a fair coin is incredibly low (and even if it's not 50/50, your call makes it so, unless you tumble to it's being loaded and take advantage). I can't imagine myself stopping after three losses in that experiment, especially if it was money someone gave me. The player would very likely have around $35 instead of $20. How often do you get to play a game you know is stacked in your favor?

    Ironically, the results must have helped the researchers stay within budget.

    After the 2009 crash I put about all I thought I could afford into the market. My only regret, to this day, is not affording more. Guess I must be a psychopath.

  • Report this Comment On October 17, 2013, at 1:03 PM, stric7 wrote:

    daveandrae wrote:

    "What makes a good investor?

    Patience.

    In 1962 the average holding period for a stock listed on the NYSE was eight years. Today, it is less than seven months...and getting worse."

    I've heard variations of this claim. Surely it is easier to buy and sell stocks but does this number count big firms that short term trade with a holding period of seconds or less?

  • Report this Comment On October 17, 2013, at 2:06 PM, ddepperman wrote:

    Read Taleb's Fooled by Randomness.

  • Report this Comment On October 17, 2013, at 2:14 PM, loachdriver4 wrote:

    Sure hope it's true that the brain damaged make effective investors. According to the neurological medicine folks who worked on me subsequent to my taking a bullet to my noggin in Viet-Nam I incurred "Massive brain damage."

    Want evidence I fought in 'Nam & was WIA?

    www.vietnamproject.ttu.edu/banshee Just check the unit roster for my name, Dave Livingston

  • Report this Comment On October 17, 2013, at 2:35 PM, TMFLomax wrote:

    Morgan,

    Great article. I was going to add all my own layman's data about people on the psychopathic spectrum and how they are uniquely wired for short-term trading -- I'll spare everyone. I do have strong feelings about this and have probably read more on that wiring than I should (it's a dark place). I'm glad to see other people writing about psychopaths and investing though. ;) (And yeah, the core takeaway of reining in our emotions and ignoring the crowd. At one point I was going to write an article linking some of the insane ups/downs/mass psychology in the marketplace to group hysteria throughout history like St. Vitus Dance, but it just never quite gelled. ;))

    Yet another PS: Schneidku40 I also found it amusing. A truly great opener. I don't think you're a bad person. ;)

  • Report this Comment On October 17, 2013, at 3:16 PM, daveandrae wrote:

    @ Stric7-

    If Big Firms were included in the aggregate, the holding period would drop down to an average of 5 DAYS!

  • Report this Comment On October 18, 2013, at 11:03 AM, stan8331 wrote:

    Yet another fantastic article. It's scary to think how few people have a viable, coherent investment strategy, and how few of those folks actually manage to execute their strategy in good times and bad. Of course the temporary market distortions created by irrational investors provide great opportunity for folks who do manage to invest rationally, but our I believe our society would be far better off in the long run with fewer of those distortions and the havoc they can bring to the lives of those impacted.

  • Report this Comment On October 18, 2013, at 12:29 PM, pannetron wrote:

    I think simply being good at math may replace the need for a brain lesion!

  • Report this Comment On October 18, 2013, at 2:17 PM, Zombie111 wrote:

    If being good at math is all that is needed, then why aren't mathematicians some of the richest people on the planet?

    Emotion usually triumphs anyway, as they are often about basic and immediate concerns/ survival, whereas successful investing is about the long-tem and abstract.

    Excellent article (but the brain lesion path is a bit hit and miss, as many lesions result in greater emotional volatility).

  • Report this Comment On October 18, 2013, at 2:38 PM, Zombie111 wrote:

    Many things are better than a brain lesion! They are hit and miss. But if math ability was all that was needed then mathematicians would be very rich.

    Emotions are about immediate reactions to threat (often) whereas successful investing is about the long-term and abstract. Guess what one wins for most of us.

  • Report this Comment On October 18, 2013, at 11:31 PM, richards4399 wrote:

    During my working life, ostensibly now over, a fair number of the CEO's and upper management people,in companies that I worked for, were clearly sociopaths (and narcissists, of course).....you know these guys. They were efficient, unemotional, decision makers. They made money. They were often good at faking a caring and charitable "heart" that was good for business. I've often thought that if there were a way to accurately identify the pirates and sociopaths that it might be an interesting investment tool. I say this last part a bit "tongue-in-cheek", but it is fun to ponder this stuff.

  • Report this Comment On October 19, 2013, at 11:13 AM, HueWhite wrote:

    Out here in the computer programming world, we have something called ISO 9000. Organizations love to be certified "ISO-9000" because some big customers won't buy unless you have that certification. While I've never been in charge of preparing for an ISO 9000 audit, this is how I see it in a nutshell:

    1. Have a process.

    2. Have it written down.

    3. Make sure everyone KNOWS it.

    4. Follow it. (Better organizations follow it even during crises.)

    5. Periodically EVALUATE it and IMPROVE it.

    Until today I'd never thought about it, but that really applies to investing.

    Hue (who doesn't do the above because he's incredibly lazy)

  • Report this Comment On October 19, 2013, at 3:44 PM, daveandrae wrote:

    Zombie wrote-

    "If being good at math is all that is needed, then why aren't mathematicians some of the richest people on the planet?"

    --------------------------------------------

    Amen.

    In this business, emotion is to logic as 19 is to 1. Thus, the dumbest person in the world dollar cost averaging into a 2 star mutual over a thirty year time horizon will STILL become wealthy as long as his doesn't panic when, not if, his portfolio is down 50% from its peak.

  • Report this Comment On October 19, 2013, at 4:01 PM, LeeG3 wrote:

    Okay I will admit up front that this is slightly off subject but to follow up on HueWhite's observation, I was an ISO-9000 certified auditor. The biggest violators of ISO programs were the management folks in charge of money decisions!

    One example: if the standard said that a project could not be started until a certain objective was met (for example a PO from the customer), it was usually a higher-up manager who would want to get started early. And guess what, many times, the customer would not pay for the work that was done before the PO was issued! One company "fixed" the problem by giving the clerk who assigned project numbers the ability to say no if there was no PO, Letter of Intent, or written approval of the company president. I watched one manager huff and puff at the clerk when she wouldn't give him the project number because he didn't have any one of the required documents. The next day the president came to her office and personally thanked her because the customer decided not to go forward with the project. Her following of the procedure saved the company a lot of money that day!

    How does this relate to investing? When you have done your research and set a price that you will buy or sell a stock, do you override that and sell/buy before the stock reaches that price? Patience is the key to investing. NEVER, EVER change what you are going to do unless there is a major change in the conditions. Yes, you may miss an opportunity by not reacting quickly but more likely, you will be better off to wait.

    Have a plan and follow it. As small investors, it is the biggest advantage that we have in a market that is dominated by large firms trading to find a 1/8 point change in the price of stocks.

    One of my rules now is that I don't buy until a stock is at the bottom of its Bollinger Band. Every time that I didn't follow that rule, it has cost me money! Yes, I have missed a few opportunities but I sleep better. It also forces me to wait after I see David and Tom's recommendations before buying so that I do my own research which includes deciding on what price I am willing to pay for their recommendations.

  • Report this Comment On October 21, 2013, at 10:14 AM, KBecks wrote:

    This one is a fun, helpful article, and I enjoyed the comments about ISO 9000 processes too, interesting stuff. Thanks for this story. :)

  • Report this Comment On October 23, 2013, at 5:36 PM, AltReality11 wrote:

    "What makes a good investor? People.....with brain damage."

    That made me chuckle. However, it could simply be that people who don't think the way some others do may be a better investor. In modern society, as an engineer and professional problem solver i have been treated somewhat roughly because "I'm a geek." What really disturbs those who put me into that trash bin "He's an engineer" is the discovery that I enjoy art, classical and modern music, am well read, have traveled, backpacked, canoed, actively contributed to and participated in not-for-profits and I am an accomplished artist, photographer, cook and baker and I and like fine wine.

    I am of the opinion that good investing requires good research and "doing the numbers." As Morgan suggested, the "long term view" is helpful.

    However, where I disagree with Morgan is the use of "functional psychopath."

    I think it's possible to learn how to make decisions void of emotion. It took me more than a few years to keep my view on the goal, and I did and I have since applied this ability in some situations in which my skin was possibly forfeit. One time, I was told "If you make a mistake the King will know." I was dealing with a really serious political and technical problem in Saudi Arabia at the time. A high level Prince made that comment to make me further aware of the seriousness of the situation. Saudi jails were 12 x 12 pits with 20 men in each; I got the point.

    My point here is that these decisions for investors are about money. It took being nearly broke for me to really come to grips with money. It's a tool. It allows me to buy stock, or take a vacation, or buy food. It's a symbol and any meaning we impart to it is an emotional one. Being broke may mean going hungry. On the other hand, it doesn't necessarily mean I will starve. The conclusions about a lack of money, or the perceived benefits of having an excess of money are all mental and in my head.

    Darwood

  • Report this Comment On October 28, 2013, at 1:17 PM, MOSHOLU1914 wrote:

    I feel almost a compulsion to add a couple of comments:

    zig is a philosopher: he, not unlike I, was the only contributor who noted that participants would be in a class which would have a different emotional reaction to a loss of money, "especially if it was money someone gave me". He goes on to state: "Ironically, the results must have helped the researchers stay within budget." Hmm, another identity which only he and I noted.

    Finally, he comments: "After the 2009 crash I put about all I thought I could afford into the market. My only regret, to this day, is not affording more. Guess I must be a psychopath." Philosopher or psychopath?

    I attended an old school run by the Jesuits and therefore was given a freebie in addition to my chosen major (English Lit.) another major: philosophy. So? So, early on, during a Friday afternoon in my Junior year, while playing "Nickle Poker" decided

    the probability of my Queens over Jacks" being beaten was worth the chance of losing ALL of my cache. The pain of "Read 'm and Weep" was far worse than the potential elation. I've never go

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