Economics

Neurofinance:Insidetheinvestor'sbrain
AttheannualSchrodersInvestorConferenceinBudapest,delegatesheardfromneurofinancierDr.
RichardPeterson,whooutlinedhowdeceivedwecanbebytheapparentrationalityofourownminds.
09Oct2015
Dr.RichardPeterson
ChiefExecutive,MarketPsychLLC
UnstructuredLearningTime

Irrationalthinking
Ourbrainsliketotakeshortcuts,andthiscanhaveseriousramificationsforinvestmentsuccessorfailure,
accordingtobehaviouraleconomistandpsychiatristDrRichardPeterson.
Dr.PetersonisChiefExecutiveOfficerofMarketpsych,apsychologybasedbigdataprovidertoasset
managers.
Certainsubconsciousshortcutsthatourbrainstakecanbeparticularlyinsidiouswhenmakinginvestment
decisions.
Researchhasshownthathumansarefarlessrationalthanstandardeconomictheoryassumes.
Thegoodnews,saysDr.Peterson,isthatmuchofthisirrationalityissystematic,andbecauseitis
repeated,itcanbepredictedandpossiblyevenprevented.
Dr.Petersondiscussedthedangersofemotionalprimingasjustoneexampleofhowwecanfallpreyto
ourbrainsshortcuts.
Emotionalprimingcanhaveamaterialimpactonourpropensitytoacceptrisk,andwhatsmore,weare
unlikelytobeawareitisevenhappening.

Investmentexperiment
Ina2007investmentexperiment,agroupofsubjectswasshowneitherahappy,fearfulorangryphotoof
ahumanface.
Thesubjectsshownthehappyfacewerefoundafterwardstoincreasetheirtoleranceforriskbyasmuch
as30%,versustheothersubjects.
Whatsmore,theexperimentsparticipantsdeniedthatthefacestheysawhadaffectedtheirjudgementat
all.
Theproblemisthatourprefrontalcortex,whichgovernsjudgementandexecutivefunctions,evolvedon
topofourdeeperlimbicsystem,whichgovernsemotionalresponses.
Theresultisthatourbrainscanactuallyoverriderationality.Thisresultsinsomeinterestingpatterns,

whichDr.PetersonfollowsthroughtheThomsonReutersMarketPsychIndices.
Statistically,hesays,Septemberistheangriestmonthoftheyear,whilstDecemberisthemost
optimistic.
Givenourdemonstrablesusceptibilitytooursurroundingsinformingdecisions,itfollowsthatcertain
emotionalqualitiesoftenmakeforbetterinvestors.
Emotionalstabilityandopennessareprimeexamplesofpersonalitytraitsthatcanbeshowntohavea
positiveimpactonreturns.

Defendingyourlogic
Thequestionis,ifaninvestorisarmedwiththisknowledge,isitpossibletoovercometheseemotional
biases?Theanswerfromsomeoftheworldsmostsuccessfulinvestorsis:yes.
AccordingtoWarrenBuffett,intellectneedhavenothingtodowithperformance,butemotionaldiscipline
isessential.
Successininvestingdoesn'tcorrelatewithI.Q.onceyou'reabovethelevelof25,WarrenBuffetthas
beenquotedassaying.
Onceyouhaveordinaryintelligence,whatyouneedisthetemperamenttocontroltheurgesthatget
otherpeopleintotroubleininvesting.
Thetemptationwheninvestorsarepresentedwithadecisionistoseekoutmoreinformation.Whatthe
aimshouldbe,saysDr.Peterson,istoseekoutbetterinformation.
Investorsshouldtrytofilteroutinputsorpeoplethatarenotaddinganythingvaluable.
Herecommendsatwostepprocesstoinvestmentdecisionmaking,inwhichinvestorsfirstmanagestress
beforetakingaction.
Ifinvestorsareconcernedaboutmarkets,theyoughttoassessthepresentcauseoftheirworriesinthe
contextofthewidermarketinfluences.
Havingdoneso,itisbesttothentomitigatetheanxietyprovokingstimulusbeforetakingaction.
Ultimately,therecognitionofourirrationalityisthemostimportantstepinovercomingit.Pickingtheright
stock,bondorfundasapartofabalancedportfolioisstillatremendouschallenge.
However,onceweareawarethatourbrainsaresusceptibletopotentiallydamagingemotionalpatterns,
wecanbetterdefendmorelogicalresponses

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