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Laura Rowley Money & Happiness

Laura Rowley, Money & Happiness

This Is Your Brain on Money

by Laura Rowley

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Posted on Thursday, October 18, 2007, 12:00AM

One afternoon on his way to lunch, New Yorker Jason Zweig found a roll of bills on the sidewalk that totaled $300.

He subsequently picked up the restaurant check for his office mates, took his girlfriend out to dinner, and splurged on some books, music, and a few classy ties. When all was said and done, he'd blown $430 -- or $130 more than his lucky strike.

Eager Spenders

Researchers have found that an unexpected windfall makes people more eager to spend than an expected one, as Zweig discovered in writing his new book, "Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich."

In the book, Zweig, a senior writer at Money magazine and editor of the revised edition of Benjamin Graham's classic "The Intelligent Investor," examines the psychological, neurological, and biological phenomena that drive foolish financial behavior.

"It's very important for people to realize that this is not a study by very smart people of how stupid the rest of us are," says Zweig. "If you talk to the researchers, they make the exact same mistakes that they spend their careers documenting."

Here are five ways your brain can trick you into making financial blunders, and how to avoid them:

1. Familiarity breeds admiration, not contempt.

Psychological research shows that we're attracted to the familiar, Zweig says. A simple test proves his point: Take a digital photo of yourself, and using photography-manipulation software, flip it to the reverse image so that if it was shot from the left, it now looks as if it was taken from the right.

"You'll have a strong preference for one of those images and not the other -- because one is your mirror image, the other is the image that people see when they look at you," says Zweig. "Whenever a stock, an industry, a market, a country, or an investing theme is familiar, you'll like it better. But familiarity is very dangerous."

One example: More than 5 million Americans have at least 60 percent of their 401(k) savings in the stock of the company where they work. Investment advisors recommend holding no more than 5 percent.

On the other hand, what about the famous advice of legendary Fidelity fund manager Peter Lynch, to invest in what you know? "That's not what Peter Lynch said," Zweig says. "He did invest in Chrysler after getting a minivan, but he didn't invest only because he liked the minivan -- he researched the stock. If he hadn't liked what he saw when he researched the company, he wouldn't have bought the stock."

Whenever you feel an investment is a no-brainer, stop and write down 8 to 10 different reasons why you must be right, Zweig advises. If you find after three or four that you can't think of any more, think twice before buying.

2. The pattern you swear you see is probably an illusion.

The brain is built to detect patterns, even when confronted with an arbitrary occurrence. "A small streak of random luck looks to us like part of a longer pattern of reliable foresight," Zweig writes.

After someone learns a set of circumstances through which they made money, the brain will fire up with the pleasure chemical dopamine when those conditions occur again. "If you see something once, then twice, you automatically, involuntarily expect it a third time," Zweig says.

"You associate a signal with a result -- 'when I listen to that guy on CNBC and I do what he tells me, I make money.' If that happens to you twice, and if you see him again on TV, dopamine is released, and you'll buy what he recommends because just seeing him will give you a good feeling. The intensity of expectation really gets you into trouble."

Investors relying on technical analysis tend to succumb to this problem. "As soon as a stock seems to conform to a pattern that has made money before, an 'I-got-it' effect kicks in, making investors feel sure they know what's coming next -- regardless of whether there's any objective reason to believe they do," Zweig explains. Even sophisticated investors tend to hire money managers who are on a three-year hot streak.

Zweig says one way to prevent your brain from reacting to these "three-peats" is to use dollar-cost averaging -- investing the same amount every month in a fund or stock that's part of as larger long-term strategy based on your goals.

3. Everything is relative.

The brain will hook onto a number and then compare subsequent figures to the initial one, a phenomenon known as "anchoring and adjustment." It's why real estate agents tend to show a potential buyer the most expensive house first, because subsequent ones will seem inexpensive; and why mutual fund companies nearly always launch new funds at a "cheap" price of $10 a share.

The solution? Avoid the numbers. Zweig quotes Warren Buffett, who says he always likes to look at investments without knowing the price, "because if you see the price, it automatically has some influence on you."

4. Tune out the play-by-play.

If you're someone who obsessively monitors the prices of your holdings, watch out. Several studies by Princeton Nobel laureate Daniel Kahneman and other researchers have found that the more often people watch an investment move up and down, the more likely they are to trade in and out short-term -- and the less likely they are to earn a high return over the long term.

"If owning stocks is a long-term project for you," Kahneman tells Zweig, "following their changes constantly is a very, very bad idea. It's the worst possible thing you can do, because people are so sensitive to short-term losses. If you count your money every day, you'll be miserable."

5. Beware of group-think.

"When the market gets really greedy or really fearful, basically everyone's brain starts to work the same way," says Zweig. "That's why many people buy high and sell low."

A New York University researcher performed MRI scans on subjects as they watched the Clint Eastwood film "The Good, the Bad and the Ugly." "Throughout most of the movie, the brain scans were all over the map," says Zweig. "Then there's a scene in which Clint Eastwood blows the bad guy's head off. Everyone had the same reaction -- fear and alarm. The lesson is that, at emotional turning points, people think alike."

To avoid following the herd, set your own financial policies and rules, and stick by them.

"Try to determine what your long-term goals are, put a really good financial plan in place, and follow it," says Zweig. "The worst imaginable thing you can do is listen to Pied Pipers who tell you 'here are seven tricks to beat the pros at the game.' That game will make you miserable."

For more tips from Zweig, see my blog.

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67 Comments

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  • Yahoo! Finance User - Monday, October 22, 2007, 11:37PM ET  Report Abuse

    • Overall: 3/5

    Interesting article; I loved where it was headed but would have liked some "brain tricks" related to something other than the stock market.

  • Nemo - Monday, October 22, 2007, 8:48PM ET  Report Abuse

    • Overall: 5/5

    I love it - reminds me of "Random Walk Down Wall Street," where the author flipped a coin, traced a line up and down according to the result, showed his students, and listened to their reaction to the "patterns" the "stock" he'd graphed had made. There is no way to game the system over the long run. I firmly believe that the research that is most likely to pay off isn't "technical" investment strategy; it's (1) finding ways to trim the taxes and pay yourself first by taking advantage of shelters such as your 401k, IRAs, mortgage interest deduction, etc.; (2) cutting overhead and diversifying - as index funds have done; (3) minding your career - your source of income; and (3) minding your spending. You may still fail - it's possible to lose a lot in the market, or to inflation if you hide your cash under a mattress; but your odds are pretty good if you exercise your self-discipline and simply do your best.

  • Yahoo! Finance User - Monday, October 22, 2007, 3:02PM ET  Report Abuse

    • Overall: 3/5

    very useful article.

  • Ben C - Monday, October 22, 2007, 12:46PM ET  Report Abuse

    • Overall: 1/5

    The real problem here is the internet has turned to world into one giant Bar / Play area where everybody get to say what ever is on their minds or make small talk to fill the silence. What Laura and the other experts are doing is no different that a group of mom's sitting in the park watching the toddlers play or guys in a bar feeling good. Picture this, Mom # 1 "would you believe I just read an article in Cosmo on how the mind goes...bla..bla..or Big Mouth Guy # 1 in the bar, "that's not true I read a study in the "Let me Impress You Book of Wisdom" which prove Stocks are ...bla.. bla...small talk, regurgitate the article and then nothing to add. After the blast off of space ship Internet we went through the turbulence of information overload, the Captain tells me we can expect to go smoothly through killing time, unique visitors, meaningless websites, copycat My spaces, we'll Google and even go Yahoo at the meteor showers of objects moving so fast you will wonder if it was a Dial up or Broadband. Fellow travelers, don't panic, we can expect a smooth landing when the space police (Uncle Sam and his foreign Cousins) stop the space ship with Taxing, Business Permits and Monitoring Fees. Read a book, it does a mind good.

  • Linavibe08 - Monday, October 22, 2007, 11:25AM ET  Report Abuse

    • Overall: 1/5

    Its all no-brainer information in the form of a textbook.

  • rizzyb - Sunday, October 21, 2007, 9:28PM ET  Report Abuse

    • Overall: 1/5

    Very basic, nothing new there ! Fear and Greed wouls have sufficed...Waisted my time reading this. Thought something new was discovered...Bla, bla,,,,bla. Better next time. But don't get wrong here, YAHOO IS THE BEST FINANCE SITE OUT THERE, GOOOD JOB.

  • Yahoo! Finance User - Sunday, October 21, 2007, 8:35PM ET  Report Abuse

    • Overall: 1/5

    What garbage. Typical mainstream I-know-more -than-you observations. Knocking technical analysis is something done by idiots who don't have the intelligence to understand it or the common sense to admit that they are people who PROFITABLY beat the market every month of the year.

  • Yahoo! Finance User - Sunday, October 21, 2007, 6:09AM ET  Report Abuse

    • Overall: 5/5

    Al-right, take my instance, the first time I made (double the investment in one day time) money was in playing black-jack (gambling). Where I made money in 1 day time and lost the money by not knowing (oh, I did know, you do or can lose money) when to stop, you can say it the question of timing. It was not a small amount of money in the cases, I am telling you here. The second time was in been a budding enterprising person in a hard (work/ labor case). Why I failed in it was two reasons. Most important reason it seem my body was not up to it. Third time, still working on it is in the stock market. Where I double my money in just 20 days but I am in a dead loss affair over the stock market. I estimated if, I ever recover the invest in the stock it will take more than 8 years to recover my money from the day of my loss in the stock market. Now why did I lose money in the stock market. It due the fact, that I did not Banked the money. So to make money in the stock market, Laura article apply very well. It about also a question timing, been in the correct place, having a sound mind, know when to take the right / correct risks know when or if to cut back on your losses, making the right calls, (Yeah the above, to can beat the experts on, / in , / at their own games.) Most important not to get sick at playing the game. I wish all well, G-d bless you all.

  • Yahoo! Finance User - Saturday, October 20, 2007, 7:12PM ET  Report Abuse

    • Overall: 4/5

    I'd a dd few things. (1) Read the News before looking at the Numbers. Changing your investment strategy should be based on changes in the situation in the company in which you have invested for the reasons you chose to do so. (2) Don't avoid looking at where the stock is going, even if you are a long term hold investor. That doesn't mean following the herd. But there are occasions to take profit if a stock has really gotten way ahead of itself, though this is rare. (3) When considering selling off what looks like a losing position, reconsider whether you would, using your original thinking, consider buying the stock at the current level if you had no position in it. A lot of people sell off a winner disguyised as a loser when they should be exploiting the situation to add significantly to their holding. Selling because it is dow is usually too late anyway and makes the brokers rich for little good reason.

  • Yahoo! Finance User - Saturday, October 20, 2007, 11:21AM ET  Report Abuse

    • Overall: 3/5

    I Happen to disagree with the notion of ignoring the bottom line on a frequent basis. I enjoy just paying attention to the total gain, or loss , at the end of the week. It does not mean I will trade, or even buy more. By the way, "no I am not a miserable person."

  • Yahoo! Finance User - Saturday, October 20, 2007, 11:18AM ET  Report Abuse

    • Overall: 5/5

    I'm guilty - have made a number of mistakes - but I have followed Ken Heebner's advice as to what he does with his own money. 90% is safe, and 10% he invests aggressively. The problem for me is there are so many great stocks - - -. What has bailed me out in life is living below our means.

  • Yahoo! Finance User - Saturday, October 20, 2007, 7:26AM ET  Report Abuse

    • Overall: 1/5

    This is an excellent article. I felt it was written about me. Unfortunately hovering over the left hand star was recorded as a Poor rating, in fact it is excellent. The two gems that struck me were Do not look at your investments every day (or in my case every hour) or you will misinterpret short term trends and trade on them. Warren Buffet is right, evaluate an investment before you look at the price. However if you were to disregard patterns you would not look at the charts. I think that charts are an essential tool to identify support and peak levels and are very helpful. You just need patience to read them not anticipate them.

  • 战士 - Saturday, October 20, 2007, 7:18AM ET  Report Abuse

    • Overall: 5/5

    Great!!! That's what we need!!! Please talk to the other experts, they may learn a lot.

  • Sam S - Saturday, October 20, 2007, 5:42AM ET  Report Abuse

    • Overall: 5/5

    There definitely is some truth to the fact that your brain does begin to play some tricks on you once you begin to have some success investing. One need look back no further than the mass hysteria of the 1999-2000 dot bomb fiasco for a perfect example. And yes from time to time you even will hear Warren Buffett say things like the time to buy is when there is blood in the streets and people jumping from windows. A prudent investor would be wise to not only fully understand the financial markets, but to also understand human psychology, the herd mentality, and the tendency to overdo risk at the first signs of success and to run for the exits when everyone else is panicking. A good investor understands both sides of the coin, when it is time to run with the herd, and when it is time to play contrarian and do the opposite of what every one else is doing.

  • Yahoo! Finance User - Friday, October 19, 2007, 11:30PM ET  Report Abuse

    • Overall: 5/5

    This is a nice article, and related to finance no less. (*ahem* Junk in the Trunk) Yahoo Finance needs more articles such as this, even though it was mostly just a mega quote of Zweig rather than an original work by Mrs. Rowley.

  • Yahoo! Finance User - Friday, October 19, 2007, 9:27PM ET  Report Abuse

    • Overall: 5/5

    We need more articles like Rowley's and less of those from the Junk Trunk.

  • Dee - Friday, October 19, 2007, 9:08PM ET  Report Abuse

    • Overall: 3/5

    Matt. Poor simple stupid matt. Go ahead and get in line with all the other group thinking sheep out there so when the crash comes you can fall in line over the cliff with the rest, while individual free thinking minds rest easy at your sight. Baaaaaaaa........ thats the sound of you group thinking DOLTS falling over the financial cliff to the fed reserve help me up im a stupid investor line,... oops I mean welfare line.

  • US - Friday, October 19, 2007, 8:16PM ET  Report Abuse

    • Overall: 4/5

    It is very well written and every word makes sense. I applied the rreasoning to myself and found in most of the points true. It is very good article and look forward to seeing more articles of this type in future. Bombay

  • pawankhind - Friday, October 19, 2007, 5:21PM ET  Report Abuse

    • Overall: 3/5

    :) Well, technical analysis alone may not be sufficient to make money in the markets, but coupled with good risk management and money management, TA can produce good enough results... Agree with many other 'brain' observations...there is a book that explains how we have socialogically evolved a lot over past 50,000 years, but our genes and bodies are pretty much the same as they were 50,000 years back. Naturally, it takes an effort to 'tame' our basic instincts...

  • Daddytimes4 - Friday, October 19, 2007, 3:54PM ET  Report Abuse

    • Overall: 3/5

    Regarding the comment by anonymous at 335 EST - There is a significant difference between a true Financial Advisor and a salesman with financial products. A financial advisor who accepts the role as your fiduciary, charges a fair fee for his/her services, and provides comprehensive financial counsel, unclouded by the temptations of large commissions ... that is a true financial advisor and one that can normally be trusted.

  • redsfaninsavannahtn - Friday, October 19, 2007, 3:31PM ET  Report Abuse

    • Overall: 4/5

    The response about #3 from a reader is what I would like to discuss. I think what the author is saying is absolutely true. Many people base their decision on the price of an investment when it is impossible to do so. The price of the stock or mutual fund (especially a fund) means nothing. Is Berkshire Hathaway a good price at $127,000 per share? How about Google at $649 per share. Many people probably looked at the price of Google when it was $200 and said, "Oh it is too high" How did they know that? They looked at the price. The value of the stock is what you need to look at. If Google had 1/2 the number of shares outstanding that it presently has outstanding, the price should be right at double what it is now. Some people would look at that and go..Wow Google is over $1000 per share...It can't be worth that much. This is why many people tend to buy stocks of companies that have a share price of $10 or below...they think that cheaper is better...they should be looking at everything else before looking at the share price. I actually once got into an argument about this with a CPA who wanted to keep a mutual fund because its share price was less than the share price of another fund that I had recommended that he purchase. He still can't see that especially in a mutual fund the share price means nothing...

  • sea_shore_dreamer - Friday, October 19, 2007, 3:10PM ET  Report Abuse

    • Overall: 3/5

    This is good advice. I'm having trouble with #3, however. The price of the stock is still one of the more important aspects of buying a stock. The concept of relativity is important to understand, I wont discount that - for example choosing to sell or buy due to a relative evaluation of previous performance is a good example of this type of this counter productive behavior.

  • GP - Friday, October 19, 2007, 2:25PM ET  Report Abuse

    • Overall: 5/5

    I base all my trading on the zodiac. I have back tested systems for years and found a system that would have provided me huge gains had I implemented it in the past. With my back testing as proof, I am now assured of making huge gains in the future. Technical analysis is great! I do have one off-topic question: can someone explain to me what "past results do not guarentee future returns" means. I see that statement in a lot of commercials.

  • Yahoo! Finance User - Friday, October 19, 2007, 2:12PM ET  Report Abuse

    • Overall: 3/5

    "If you count your money every day, you'll be miserable." I find that people who count their money every day have some to count. People whose finances are on the rocks often avoid facing the truth of their situation.

  • Yahoo! Finance User - Friday, October 19, 2007, 2:09PM ET  Report Abuse

    • Overall: 5/5

    Laura....is good.....I hope her next artcile is on global economics and trends....and how it might effect us.

  • Yahoo! Finance User - Friday, October 19, 2007, 1:58PM ET  Report Abuse

    • Overall: 5/5

    Great commentary! I'll recommend this book to my circle of friends and family.

  • JP - Friday, October 19, 2007, 1:45PM ET  Report Abuse

    • Overall: 5/5

    "The pattern you swear you see is probably an illusion." This is the basis of all technical analysis. Study after study of TA shows no correlation with returns.

  • Frank - Friday, October 19, 2007, 1:41PM ET  Report Abuse

    • Overall: 4/5

    I enjoyed the article.It's a logical way to make money long term.

  • Eugene - Friday, October 19, 2007, 1:18PM ET  Report Abuse

    • Overall: 5/5

    I'm so glad someone finally touched on behavioral finance because it's the most important part! I HIGHLY recommend "Why Smart People Make Big Money Mistakes" for anyone wanting to identify the errors they make when it comes to investing and how to correct them. It's a fantastic read! (http://www.amazon.com/dp/0684859386/?tag=varsblah-20)

  • Yahoo! Finance User - Friday, October 19, 2007, 1:15PM ET  Report Abuse

    • Overall: 4/5

    Great article title! (contents not bad either)

Showing comments 6-35 of 67<< PreviousNext >>
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