Your Money & Your Brain - Surprise (READ THIS)

Jason Zweig writes the following in chapter 8: "After writing about Wall Street since 1987 and studying centuries worth of financial history, I have become convinced that the prevailing view of what the future holds is almost always wrong. In fact, the only incontrovertible evidence that the past offers about the financial markets is that they will surprise us in the future. The corollary to this historical law is that the future will most brutally surprise those who are the most certain they understand it. Sooner or later, sometimes slowly and sometimes suddenly - but with a diabolical ability to root out everyone who has ever gazed into a crystal ball - the financial markets will humiliate whoever thinks he knows whats coming"

Zweig wrote the above in 2007.

I like this because it flies in the face of all the CNBC and financial prognosticators who are so confident they know the next turn of the market or hot stock or hot sector.

In this chapter on surprise Zweig explains that it is our anterior cingulate cortex (ACC) that tunes the rest of our brain to danger. Its part of our intuitive system that helps us respond quickly to danger. In the biological world that we live in, it is more important to respond quickly to dangers versus successes.

This helps account for our panic when markets start to fall.

Zweig reminds us to:

* Remember that "everyone knows nothing" - what everybody knows is already embedded in the price, so what everybody knows does not give you an edge. Unless you have some great insight, you don't know anything that the market has already built into the price.

and that,

*High hopes cause trouble. Growth stocks that miss earnings by just a small amount can spell big losses. Conversely, value stocks tend to have low hopes and so when positive news on a value stock becomes public they tend to have large increases. Classic examples of our brain reacting to surprises.

Your Money & Your Brain - Fear

Chapter 7 of YM & YB discusses fear. The manner in which our brains process fear has a large effect on how we invest.

The more vivid and imaginable a risk is the scarier it feels, and the ensuing fear is effected by what psychologists call "dread" and "knowability."

Dread is determined by how vivid or catastrophic an event seems to be.

Knowability is how immediate or specific the consequences appear to be. Plane crashes seem more "knowable" than health dangers brought on by pesticides.

When we feel we understand the situation and are in control we underestimate the risks. We tend to be more fearful of flying than driving after having a couple of drinks. Yet, the driving is much riskier.

We have a greater fear of losing all our money in a market crash versus losing our nest egg to inflation. The dread and unknowabilty dominate our thinking.

Your brains amygdala, which is part of your reflexive brains alarm system, further contributes to potentially bad investment decisions. This part of your brain responds to all kinds of signals and even words. So when you watch a news story of a bad day on the trading floor, you see traders arms gesturing wildly, clanging bells, and you hear alarming words: crash, panic, etc.

Studies show that when you see this, your armygdala is very active and is filling you with fear signals.

Zweig recommends several tactics that you can use to keep your fears in check:

1. When you feel overwhelmed with fear. take a time out. Let your circuits settle.

2. Ask yourself:

* other than price, what else has changed?

* are my original reasons to invest still valid?

* If i liked this investment at a higher price, do I like it now that it is cheaper?

3. Resist the pull of the herd. Ask someone who may not have an interest in your investment whether the fear is reasonable and if you were in my shoes what other information would you require before making a decision.