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Monday, December 3, 2007
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Investment tips found under water
by Stephen Butler
Old dogs can learn new tricks -- my wife and I discovered this
when we decided to take scuba diving lessons here in Concord.
Instead of Monterey Bay, however, we opted to do our open water
dive requirement last week in 82-degree water on Grand Cayman
Island at our son's vet school graduation. Floating in a weightless
environment totally at the mercy of the water and an artificial
air supply somehow reminded me of investing in the stock market.
I found a lot to worry about at a depth of 60 feet, where there's
that much distance to get to the air supply I take for granted.
But diving is intoxicating. It's a strange new world with a landscape
and animal life (well, fish) that you never see under any other
circumstances.
You float effortlessly in this three-dimensional space while
being careful to keep track of your "buddy" -- this
is in case something happens to your air supply or theirs. For
inexperienced divers like me, there is always the specter of Murphy's
Law, so the concern about losing air or getting caught in some
kelp never quite goes away.
The struggle to control the environment established, for me,
the link between scuba diving and investing. I spent the week
carefully reading Jason Zweig's new soon-to-be-a-classic book
called "Your Money and Your Brain -- How the New Science
of Neuroeconomics Can Help Make You Rich."
This book offers a follow-up to an earlier favorite of mine,
"Why Smart People Make Big Money Mistakes."
In simple terms, our brains mess with our heads. Thanks to medical
imaging and scanning, we can determine what parts of our brains
are gearing up to struggle with different types of investment
decisions and risk.
Zweig's book actually has photographs of the parts of the brain
that literally light up when struggling with different financial
challenges. In far too many cases, our brains get it wrong. In
even more cases, the brains we think we're hiring (and to which
we may be paying a lot of money) also are getting it wrong.
The book is chock full of examples, but to explore a few of the
better ones, we can start with the "prediction addiction."
This is the struggle for the brain to create some order out of
random events. Once we have stumbled into a collection of events
that actually lead to making some money for us, it is like a needle
in the arm. In fact, the expectation that we will make money again
gives us more of a "kick" than actually making the money
itself, if we happen to be so lucky.
Dopamine is one of the key engines of brain chemistry, and the
excitement of discovering a pattern that has made money for us
in the past gives our brains the same level of dopamine that a
hit of cocaine would produce. Harvard Medical School has done
studies showing that the brain scan of a cocaine addict generates
exactly the same neuron-firing pattern as the one exhibited by
someone who thinks they are about to make money.
The prediction addiction swings into gear even on an unconscious
level when we are struggling to make a totally-informed decision.
It only takes about three factors from some previous profitable
experience to reassert themselves before we throw all caution
(and further reflection) out the window.
"Controlling the controllable" is one of the basic
lessons of the book. All too often, we waste our time trying to
read investment tea leaves instead of just focusing on what we
control and making sure we aren't making mistakes in areas that
are guaranteed to improve our results.
One example of a "controllable" is our expectation
of what the market will earn. If we think we will consistently
beat a market that has averaged 10 percent, we are setting ourselves
up for a big disappointment.
Another controllable is cost. Paying too much for investment
advice and letting someone else's misguided brain mess with our
head (and our money) is obviously a controllable that can be set
straight. Costs also include taxes triggered by investment decisions.
"Will the expected additional gain of this investment change
more than compensate for the taxes that will, with 100 percent
certainty, eat into my nest egg?"
Then there's risk. When markets are going up, all those tests
we can take online indicate that we can all handle plenty of risk.
In down markets, the same tests applied to the same groups of
people indicate that a far lower level of risk is acceptable.
I must say, if I were limited to a single investment book to
recommend for someone reasonably sophisticated who wanted to get
to the next plateau, Zweig's book would be it.
It covers all the basic fundamentals while illustrating how powerfully
the mind conspires to make us ignore the fundamentals. As Zweig
points out: "They don't call it 'dopamine' for nothing."
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