Why do smart people make stupid financial choices—and how can they avoid repeating them? Having a head for investing, it turns out, isn't about doing arithmetic on napkins or studying spreadsheets. In fact, a key requirement is modesty and self-awareness, says Money magazine senior writer Jason Zweig, author of "Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich" (Simon & Schuster. $26). Zweig endured a series of MRIs to see for himself how the brain responds to financial challenges, and he culled insight from the growing field of neuroeconomics, which studies the biochemistry of our financial behavior. NEWSWEEK's Temma Ehrenfeld spoke to the author about the perils of our brain-triggered responses, how avid investors are like drug addicts and why women really are better investors. Excerpts:
NEWSWEEK: You're a financial writer. Did any one piece of research inspire you to go off in a new direction and write a book about neuroscience and psychology?
Jason Zweig: Years ago, I read about a series of brilliant experiments done by Paul Andreassen, a psychologist at Harvard. He tested an idea many considered a self-evident truth: the more information you have on your investments, the higher your return. He tested one group of investors in an artificial stock market that were kept virtually in the dark about their investments. Another got regular news and price updates. The surprise was that the people with less information made more money, because they traded less often. The more you trade, the less you keep, because you have to pay all the intermediaries in the system.
It's also true that the more often you look at prices, the sooner you'll see a pattern. Unfortunately, almost everything that looks like a pattern in the stock market is pure noise.
Something tells me many investors won't be happy to hear that. What point in your book gets the most resistance?
The fact that investment decisions are influenced by unconscious bias and emotion. There's reams of evidence that people make important decisions based on trivial and irrelevant factors like whether the initials of the stock match your own. But people refuse to believe that.
You write that "the neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine." If being an avid investor is like being an addict, how do I know when I'm behaving dangerously?
If you're watching Jim Cramer's show more than once a year, you have a problem. Denial is the first sign. Listen to your family and friends and pick up on social cues. Your spouse knows if you're an addict.
According to the new field of neuroeconomics, do women and men invest differently?
Women are still better investors than men. They have less appetite for bad risk-taking. They make fewer errors, and those they make are less severe. There's also evidence that hormones change financial behavior. Oxytocin, the hormone exchanged between a woman and her baby when she's breast-feeding, makes you more trusting. If you and I were negotiating a business deal, and you put oxytocin into my sinus inhaler, you'd be able to roll me. Speculatively speaking, people with greater activity in the right prefrontal cortex tend to be more risk averse, and women are supposed to be more "right-brained."
But risk aversion doesn't always lead to the highest rate of return. For instance, I have a friend who won't sell stocks her father bought decades ago. Why is familiarity so comforting?
For many years, AT&T was the most widely held stock in America, primarily because people inherited it from their parents. A lot of stocks are like family heirlooms. It's hard to let go because the brain is like modeling clay. Once you make an impression on it, it's there. To sell your dad's AT&T is like selling dad. The best advice you can give someone like your friend is to suggest not that she sell dad's stock, but that she buy more of other stocks.
You cite research showing that people feel fear whenever they make a decision that goes against the crowd—like buying low and selling high. Are we afraid of being wrong or of social rejection?
In one study, people [undergoing] brain scans were asked whether they agreed or disagreed with a computer or another person in response to a test question. When [there was agreement], the activity in their prefrontal cortex—where we do analysis—went down. The task became a mindless choice.
Where it got interesting was when people [disagreed]. Then there was intense activity in the prefrontal cortex and firings in the amygdala, one of the brain's fear centers that is also sensitive to social rejection. Disagreeing with the computer was significantly less stressful than disagreeing with a person.
That suggests that monitoring online forums or financial news only makes it harder to buck the crowd and sell high, when everyone else is buying.
It's easy to hear from a crotchety crank online, but to find substantive content that goes against the grain is no easier online than anywhere else, and you may get swamped. It's hard for the contrarian voice to float to the surface.
Another problem with online forums and financial news is that the telling anecdote dominates the statistical evidence. Anecdotes appeal to the intuitive, emotional brain. Statistical information doesn't speak to the emotions and that's why people don't act on it. You could tell people that one of the safest ways to travel is by commercial airliner. In fact, people already know that. But if they see footage of a plane crash on CNN, forget about the statistics. They'll be happy to drive without a seatbelt after drinking two beers, but they won't get on a plane.
So what's a return-hungry investor to do?
Investing is like dieting. There's a million dieting books and videos and Web sites. But everybody already knows exactly how to lose weight—eat less, exercise more. It's simple. But it's not easy in a world full of greasy food and soft couches. Also like dieting, investing is simple, but not easy. What makes investing hard is all the emotional distractions. If people could remember that it's simple and follow the few rules that can enable you to put a simple plan in place, we'd never need to worry. You don't need to beat the market to be a successful investor. If you measure success that way, you've already set yourself up for failure.