Sunday, July 22, 2012

Brains are Wired to Produce Long-Term Losses

“Don't blame me for the way my mind is wired, nor how I made wrong choices over my investment life.” This statement is a cop-out,  equivalent to the old Flip Wilson line "the devil made me do it."

One of the reasons to read Jason Zweig's column in the Wall Street Journal every Saturday is that he is one of the few columnists who regularly reads, understands, and reports on academic papers found in the learned journals.

Brain wiring produces long-term losses

In Jason's column this week, he reports on a study published by the Journal of Neuroscience. The authors of the paper were professors/researchers from Caltech, NYU, and the University of Iowa. (Disclosure: I am a trustee of Caltech and have supported some of its work in examining how brain functions drive investment decisions. Furthermore, I seek to keep current with NYU and the University of Iowa, as a grandniece is entering NYU and Ruth and I know a number of successful graduates from UI.)  These studies indicate that most people rely on short-term memory to shape their actions. Therefore immediate past successes count more than longer-term experiences. (My technical analyst friends have known this for years under the rubric of momentum investing.)  This pattern conforms to Newton's First Law of Motion whereby a body in motion stays in motion, or as commodity players often believe, "the trend is your friend." The portion of the brain that is wired to produce these results is called  the "frontopolar cortex." People with a damaged frontopolar cortex do not rely on short-term memory, but are more influenced by a combination of long-term trends.

Performance significance

While there are not many short-term traders that have been able to put together a career history of above-average investment results, there are more successful long-term investors. The secret to their results stems from the ability to buy sound companies when they are unpopular. I have known a few of the managers that exhibit these attributes, including Warren Buffett, Charlie Munger, John Neff, and Sir John Templeton. 

In terms of today's global markets, I would suggest that a heavy commitment to growth-focused mutual funds or equities would be a good place to start.

The same rules apply in the political world

The current crop of political leaders are also reacting to short-term focused issues in preference to addressing the longer-term problems. Their global focus is on the momentum in the latest polls, or what American political leaders call the "Big Mo." These are politicians not statesman. Perhaps even worse is the tendency of central bankers to follow the politicians rather than to focus on the structural threats to their nations.

Forthcoming blogs

Ruth and I are in California for the Caltech board meeting after listening to good music at the Aspen Music Festival. I suspect next week's blog or the ones thereafter will focus on investing in technology and the importance of what is happening in China. If you have any views on these topics, please share.
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