Thinking and Feeling Part I

The second chapter of TM&YB starts the exploration of our brains functioning. Zweig argues that our best financial decisions are made by drawing on both the reflexive brain and the the reflective brain.

The reflexive brain is that part of your brain that reacts to external stimuli, sometimes within a tenth of a second. It has developed to protect us from risk in our environment. It operates below the level of consciousness.

This is important to understand because your reflexive system is so fixated on change it is hard to focus on what remains constant. For example, we react to a 100 point drop in the Dow, but we don't keep it in context that it is only a 1% drop. Academic studies have shown that investors who focus on price levels outperform those who focus on price changes.

The reflective brain organizes information, categorizes it and tries to develop patterns. But, you cant depend on your reflective abilities, they are limited by your memory and the complexity of the problem. Zweig argues, that through his experience, doctors and engineers are poor investors because they try to find patterns and they miss the unforeseen event that renders their system useless.

Zweig then summarizes this tug of war with the great example of how this works when investors choose mutual funds. Most investors focus on the flashy factors when choosing a mutual fund: mutual fund manager, recent performance, reputation. They ignore fund expenses, which rigorous study has shown to be the most critical factor in predicting future performance.