Wall Street Journal columnist Jason Zweig has written on just about every topic imaginable when it comes to the world of personal finance. His book Your Money & Your Brain covers a gamut of emotions and biases that we’re likely to experience when dealing with money. The major theme, as Zweig puts it
“…our investing brains often drive us to do things that make no logical sense. That does not make us irrational. It makes us human. Our brains were originally designed to get more of whatever would improve our odds of survival and avoid whatever would worsen the odds. Emotional circuits deep in our brains make us instinctively crave whatever feels likely to be rewarding–and shun whatever seems liable to be risky.” [1a]
In other words our minds are still quite primitive. The mental processes and emotions that evolved to help our ancient ancestors survive have resulted in some unintended consequences when it comes to dealing with modern day financial decisions. Using a combination of psychological evidence and easy to understand examples Zweig takes readers through the progression of emotions that they are likely to experience when managing their finances and investments
I just recently saw the film The Experimenter which covers the work of social psychologist Stanley Milgram. His work in the early 1960’s was influenced by the behavior of Nazi war criminals who obediently followed orders, but in the process inflicted a tremendous amount of pain, suffering and death on other humans. Milgram sought to understand how humans could listen to authority even when their orders required them to perform such a heinous act.
The field of behavioral finance has been exploding in the past few decades. Daniel Kahneman, Robert Shiller and Richard Thaler (among others) have provided investors and the broader financial industry with a unique look at how emotions and psychology affect investment decisions. While many of the books out there today deal with the psychological aspects of investing, few dig deeper into the physiological side. The Hour Between Dog And Wolf by John Coates takes a closer examination of the feedback loop between body and mind. He explores this interaction and offers an explanation as to how it affects our ability to make decisions and take risk.
The film adaptation of Michael Lewis’ The Big Short is due in theaters this week. The release presents an opportunity to reflect on how and why the US mortgage industry almost drove the global economy off a cliff. Chief among these was the behavior of the various parties involved, from borrowers to investors. As a friend of mine once told me: if you really want to understand the behavior of people or institutions pay close attention to the incentives that are available to them. Here’s a few examples of how the incentives available to multiple parties helped create a massive economic calamity.
Warren Buffett is without a doubt one of the greatest investors to walk the planet. Writing about him on a personal finance blog is cliché to say the least. His track record, a 21.6% annualized rate of return over 50 years, is incredible and likely never to be repeated. What I find more impressive than the returns and dollars he’s generated is his temperament. His common sense wisdom, supported by his actions and behavior provide investors of all levels with some valuable lessons.