Some excerpts from another Zweig interview...

 

Mind Over Money

We spoke with Zweig, now collaborating on a book with Nobel Prize-winning psychologist Daniel Kahneman , to learn the ways in which financial advisors can apply neuroeconomics in their practices.

Can neuroeconomics help make advisors better investors?

It can certainly help you understand clients better. You can also use it as a mirror to ask yourself, “What am I actually good at?” Most people aren’t as good at most things as they believe they are. We all have an inner con man who lies to us about our past, our future and even the present.

Are advisors’ brains different from the brains of investors who aren’t professionals?

I’m very sad to say that I think they don’t differ. Overconfidence is probably the thing that trips up more people than anything else. It’s very hard for professionals who have real expertise to admit the limits of that expertise. Financial advisors may provide great advice on the mechanics of investing and financial planning, but I’m very skeptical that most advisors can add value by picking stocks or mutual funds.

You write that “the neural activity of someone whose investments are making money is indistinguishable from that of someone high on cocaine.” So this goes for advisors too?

There’s no doubt that professionals are as subject to these kinds of influences. It’s a myth that advisors are more rational or logical or less emotional than clients. If you’re an advisor who picked a mutual fund that turns out to be the top performing fund in America three years in a row and you think you can walk on water, you’re kidding yourself.

How should advisors approach investing , then?

What all the research boils down to is not to make decisions but rather to follow rules and procedures and to act in accordance with policy. If you make decisions, you’re being reactive to what other people or the market is doing. If you own Intel, let’s say, and you buy more because it’s going up and you’re on a hot streak, that addiction kicks in. When it goes down, you might sell in a panic. The more procedures you put in place, the fewer decisions you have to make, the fewer things you have to justify to clients and the fewer mistakes you’ll make.

You say neuroeconomics shows that the brain is more aroused when you’re anticipating an investment profit than when you actually get one. What a bummer!

This new idea tells us that expecting an outcome is emotionally much more intense than experiencing the same outcome. And that’s true both on the upside and the downside. The fear of loss usually turns out to be worse than the actual loss, which is why so many clients take less risk than they should.

What if anticipation about an investment outcome generates wild excitement in an advisor?

A simple solution is to keep an emotional journal. Once a day, religiously, make a little note about your gut feelings as to where the financial markets are headed, such as, “How do I feel about my portfolios today? I’m really happy about how things went. It makes me feel good.”

Every once in a while, take a look at what your emotions were telling you and what happened afterward. You’ll learn that if you turn them upside-down, your own emotions are a very good guide to what’s about to happen in the markets. I don’t believe that investors or advisors can turn their emotions off. But I do believe you can learn to turn them inside-out. The way you do that is by seeing how unreliable they are. This will enable you to cure your hindsight bias and to learn that by investing in the grip of emotion, you will always get things backwards.

Is there a related phenomenon regarding clients?

Yes, how easy or difficult things are to understand also sends a signal. For example, when investors read stock and mutual fund prospectuses with numerous pages of disclosure about every conceivable risk, what happens in their minds is a huge backfire effect. They think, “I can’t believe how much stuff is here, and I can’t understand any of it.”

How can advisors use this finding?

The very important lesson is that if you want clients to accept something readily, make it simple, clear and compelling. If you want to turn people away from something, give them mountains of documentation. It will make them feel: this is too hard to understand, so it can’t be very good.

What can financial advisors do to try to prevent this from occurring when it comes to clients’ emotions?

An advisor who has a long-term perspective has to make sure that everything in their office is in accord with that principle. If you’re talking to a client about holding stocks and mutual funds for five years or longer and there’s a Bloomberg terminal on your desk or CNBC playing in the background, you’ve blown it.

When asked what keeps most individual investors from succeeding, Graham had a concise answer: “The primary cause of failure is that they pay too much attention to what the stock market is doing currently.”

Excerpted from Jason Zweig's commentary on chapter 8 of The Intelligent Investor.

 

 

 

When there is a conflict between Will and Imagination, it is the latter that always wins...

Companies and their promoters should be more 'Will' oriented rather than Imagination...

Unfortunately, these days Visionary promoters are more Imagination oriented and people seem to like their painted rosy pictures or 'khayali pulao'

‘Men Take Bigger Financial Risks When Shown Erotic Images’ A new brain-scan study may help explain what’s going on in the minds of financial titans when they take risky monetary gambles—s*x. When young men were shown erotic pictures, they were more likely to make a larger financial gamble than if they were shown a picture of something scary, such a snake, or something neutral, such as a stapler, new researchers suggests. The arousing pictures lit up the same part of the brain that lights up when financial risks are taken.     “You have a need in an evolutionary sense for both money and women. They trigger the same brain area,” said Camelia Kuhnen, a Northwestern University finance professor who conducted the study with a Stanford University psychologist.     Stanford psychologist Brian Knutson, a lead author of the study, says it’s all about the power of emotion and arousal and our financial decisions.       The results of the study jibe with the real life on the trading floor, said Phil Flynn, a former Chicago commodities floor trader and current analyst at Alaron Trading Corp. “When you talk about all the euphemisms for trading (on the floor), they can be used for sex as well.”     It’s part of a new but growing field called neuroeconomics that attempts to take the hard-wired science of brain biology and mix it with the softer sciences of psychology and economics to figure out why we make the financial decisions we do. Source: TOI-Pune, Pg 16

These things partly explain strange behaviour of Investment Bankers, CFOs who played Fx derivatives game on the pretext of hedging, and of course many Mungerilals.

As the saying goes....it's all in the mind! Having said that, I received sms few days ago:

A man who goes to sleep with problem in mind, wakes up with a solution in hand.

But with this sub-prime, CDOs & entire derivatives mess.....we need to twist that message like this: A man who goes to sleep with solution in mind, wakes up with a problem in hand.