Using sophisticated MRI technology, various behavioral finance and neuroeconomic gurus have been looking deep into the decision-making activities of the investor’s brain. What they’ve discovered was that investors consistently make decisions using the lower, primitive brain functions—not the rational brain in frontal cortex—as investors we rely on what in ancient oriental cultures is called the “monkey-brain,” and what modern neuroscientists referred to as the “lizard” or “reptilian” brain. In short, the investor’s brain works like heat-seeking missile searching for immediate gratification, making buy, sell and trade decisions based on primitive short-term pleasure-pain motivators that relieve our momentary feelings of fear and greed, and in the process, we suppress, minimize and ignore long-term considerations.

No, it’s not very complimentary, but it is true: Terry Burnham, a former Goldman Sachs trader calls it a “lizard” brain. Clotaire Rapaille, a French neuro-marketing guru generalizes, it’s your “reptilian” brain. And up at Harvard there’s a wiseguy professor who refers to the investor’s primary decision-making tool in even less flattering terms: “Rat” brain!

Lizard? Rat? Reptilian? Get a grip guys, you sound more like some mean-spirited politicians than members of the world’s elite institutions and academies. But we get the point. You’re talking about our primitive brain, which research consistently proves is a very bad tool for making investment decisions … and yet, like addicts, we can’t stop the insanity, we keep using a flawed tool. Yes, you heard right: Your brain is handicapped, your brain is a saboteur costing you big money. In Mean Markets & Lizard Brains, former Goldman trader Terry Burnham says our primitive brain was designed to help our ancestors hunt for food, daily survival stuff.

But “by its very nature, investing requires us to be forward looking, to anticipate events. Our lizard brains, however, are designed to look backward. Thus, the lizard brain causes us to be optimistic at market peaks (after rises) and to be pessimistic at market bottoms (after falls).” So whether it’s optimism or pessimism, greed or fear, your emotions do your investing, not reasoning and logic—and you can’t trust them.

Harvard gambles with Wall Street’s “rat” brains

And it’s not just you. The best and the brightest are also trapped by this saboteur, their primitive brains. There was a great article in SmartMoney magazine, “Outsmarting Your Brain:” Harvard Business School professor Max Bazerman was speaking to a conference of 75 Wall Street power-players, guys commanding six-to-seven figure incomes for managing your money.

Max opened by auctioning off a $100 bill. Simple rules: The highest bidder gets the $100 bill. And the second highest pays what he bid, but gets nothing. Forty hands quickly pushed the bidding to $95. Then a couple presumably rational hot-shots, an institutional money manager and a pension-fund trustee, broke the $100 barrier, after which both were guaranteed losers.

Imagine the insanity: Two of America’s financial geniuses caught up in a hotly contested duel, pushing the bids up, up, up … to $465!

That’s right, the winner bid $465—for a $100 bill!

The best and the brightest have lizard brains too

If you’ve ever doubted that investors are controlled by an irrational rat brain, the professor adds this scary observation: “I’ve played this game perhaps 600 times, and I’ve never seen the bidding stop below $100.” Yikes! It turns out that the best-and-brightest managing the $10 trillion mutual fund industry are just as irrational as the rest of America’s 95 million average folks who trust them with their money. The blind are leading the blind. We are all playing the stock market game like rats and lizards chasing around in a maze for cheese … while telling ourselves we’re rational.

Get it? Our brain is our worst enemy. When it comes to investing, we still make decisions using a self-sabotaging primitive brain. Here’s Burnham’s summary: “We need to precisely restrain our instincts in order to make money. Unlike neural games of chance, or ancestral problems like gathering and hunting, financial success means suppressing out ‘gut’ instincts.” Here are his eight rules to restrain this saboteur.

One. “Don’t Trade Emotionally, Unless You’re Tom Cruise”
Actually, he’s referring to Cruise’s role as “Maverick” the jet fighter pilot in the film, Top Gun. Movies keep our myths alive. In fantasies we cheer the superiority of our gut instincts as the hero shoots down enemy fighter jets, winning a great battle in the final scenes. But c’mon folks, get real, it’s just a movie. In real life Tom is just little irrational Tommy jumping on Oprah’s couch. So when you’re investing on Wall Street’s couch: “Trade as little as possible.”
Two. “Never Trust Anyone, Not Even Yourself”
The rest of Burnham’s warnings emphasize this “new science of irrationality.” You should never trade impulsively on tips, from your barber, from your best friend, your broker—and especially not on tips from your lizard brain: “Always include a significant delay between an investment idea and an actual trade.
Three. “Losers Average Losers”
Remember: “Even great and experienced traders must fight the impulse to hang onto and average into losers.” Get out. Stop playing macho-man. The lizard brain hates losing, so it wants to hangs on, and on, and loses (again).
Four. “Do Not Dollar Cost Average”
This rule applies to trading individual stocks. Less so when adding to a diversified portfolio as part of a regular savings program. But he warns traders to listen closely: “While dollar-cost averaging works in bull markets, it is not profitable in long-term declines.”
Five. “Do Not Open Your Mutual Fund Statements”
Actually Terry’s talking about ignoring all news, including cable TV. By the time you get any “breaking news,” it’s too late, there’s no trading value. Wall Street insiders had it and acted on it long before it became “news” and you see it. Worse yet, your lizard-rat brain will make the mistake of reading something into random news, compounding your mistakes.
Six. “Spin Control for Yourself”
Lizards and rats hate to lose. But since they can’t focus on the big picture or on the future, they are destined to lose anyway. They’re accident-prone when it comes to investing. Solution: Focus on your portfolio as a whole, and stop tinkering with it.
Seven. “When to Go ‘All In’ ”
Remember “The Gambler” song, by Kenny Rogers: “You gotta know when to hold’em, when to fold’em.” You also gotta know when to go “all in” (bet everything). Which is rarely. But the hyperactive rat-lizard brain still does it. Unfortunately, when you’re in the Wall Street casino, fighting to survive against thousands of professional rats, lizards and other hostile animals who are trying heard to pick the meat off your bones all day, every day … well, maybe you ought not even be in that casino.
Eight. “Do Not Get The Key To The Minibar”
In short, cheap discount trades make irrational trading too easy, like hotel minibar keys that make it easy to spend $10 for a mini-package of cashews. So “those who trade too much should arrange their finances so that impulsive trades are not possible. Remove temptation: do not expect to resist it.”

Solution: Terry puts the bulk of his family’s assets with a full-service broker who charges a whopping $100 a trade. Here’s my solution. Stop trading altogether, stop rebalancing … turn off your primitive brain by building a passive, well-diversified portfolio of no-load index funds. Either way works.

But as soon as I say that, my psychic brain hears all the rat-lizard brains out there conspiring to chew the wiring in my computer, then go hunting for their next meal at the Wall Street casino. Their primitive brains are convinced that with the right tips they’ll go “all-in” and finally beat The Street’s best-and-the-brightest rodents and reptiles. So they tune me out, convinced I couldn’t possible understand their unique brand of instinctual “Maverick” genius as a trader. So they’ll continue jumping up and down on Oprah’s couch like an irrational child (metaphorically, of course), proving again and again that the investor’s primitive brain really is a saboteur.

FirstPubDate: Aug’06