Ended: July 3, 2011
Also, when tasting the same wine, the wine tasters invariably reported superior taste for the wine that came out of the $90 bottle than for the wine that came from the significantly cheaper bottle. But there were additional data that made the experiment even more interesting. Since reported taste is a poor measure of true taste experience, researchers used functional magnetic resonance imaging (fMRI) scanning machines to image participants’ brains as they tasted the wines, and what was revealed was fascinating. When a participant was tasting the wine out of the cheap bottle, the medial orbitofrontal cortex—an area of the brain that is strongly related to experiences of pleasure—showed little activity. But when the exact same wine was poured out of a $90 bottle, what do you think happened? The brain showed levels of activation that indicated that significantly more enjoyment was experienced from the exact same fermented grapes. The study made it clear that the price tag has a physiological effect on taste, and that expectations alone were sufficient to influence taste experience. The Stanford wine group expected the wine to taste better, and so it did.
Socrates once famously said, “The unexamined life is not worth living,” by which he meant that to enjoy a fulfilled life, we must question our thoughts and actions.
With regard to money, we would all be wiser to say that the unexamined mind is not capable of successful investing. There is value in analyzing our motivation to invest, to inspect it critically, and to constantly ask ourselves the philosopher’s simple question, why? Top investors spend their careers engaged in this practice, consciously and unconsciously, which, in my experience, accounts for their success. But unfortunately, even if you accomplish this, it is not enough. BLACK SWANS
behavioral economist Daniel Kahneman has observed, “Financial decision-making is not necessarily about money. It’s also about intangible motives like avoiding regret or achieving pride.” No wonder there is often a distance between our investment hopes and practices.
“I remind myself that the market action that gives rise to a strong impulse in me is having a similar effect on thousands of other market participants, and that’s probably not a herd mentality I want to be a part of.”
“The brain is not a computer that simply executes genetically predetermined programs. Nor is it a passive grey cabbage, victim to the environmental influences that bear upon it. Genes and environment interact to continually change the brain from the time we are conceived until the moment we die. And we, the owners—to the extent that our genes allow it—can actively shape the way our brains develop throughout the course of our lives.”
Seasoned investors calculate losses before they happen. They are aware of the feelings and
states of mind that a loss engenders. Yet, with strict risk management, they are able to override their natural inclination to flee from a psychologically and physiologically disturbing experience.
“Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
NYU neuroeconomics professor Paul W. Glimcher suggests that we may be using two different strategies when we are inferring the mental states of others. In one strategy, we simulate the other person based on knowledge that we have about ourselves; with the other strategy, we assume, or infer, the mental states of the other person based on more abstract knowledge that we have about the world. He said that the second strategy “may also involve knowledge about stereotypes, and raises the interesting question as to whether judging another person’s mental state may be biased in different ways depending on whether we perceive them as similar or dissimilar to ourselves.”
The key point here is that success depends on a strong subjective awareness of yourself as well as an objective understanding of the market (which is made up of others), armed with strategy and risk control without fear or wishful thinking.
“Much of what behavioralists cite as counterexamples to economic rationality—loss aversion, overconfidence, overreaction, mental accounting, and other behavioral biases—are, in fact, consistent with an evolutionary model of individuals adapting to a changing environment via simple heuristics,” said Lo.
The fundamental insight of the Adaptive Market Hypothesis is its emphasis on the constant organic reshaping of the market, where economic activity often does not exhibit equilibrium, or that point at which quantity demanded and quantity supplied are equal. In Lo’s theory, risk and reward are not necessarily stable over time, and arbitrage opportunities exist because prices are not random.
Underlying all of this is not the maximization of profit and utility, but rather the biological imperative of survival. Investors and markets are engaged in the naturally selective process of innovation, learning to adapt to a changing economic ecology. This idea echoes a comment made to me by market wizard Jeffrey L. Silverman, who coincidentally was educated at MIT. When I interviewed him in his Mercantile Exchange office, Silverman said, “Traders evolve and markets evolve. The role of the investor is just to evolve faster than everyone else.”
Taking ultimatum game research up a notch, Berkeley assistant professor Eduardo Andrade and MIT’s Dan Ariely used the game-playing science experiment to show that not only are stingy offers refused when they are perceived to be unfair, but when emotional stimuli are present, players reject offers that would otherwise be accepted. They consistently found that emotion trumped self-interest.
The results for the effect of each emotion were both controversial and interesting. In the case of sadness, individuals became self-absorbed and liable to pay more for goods, in the unconscious belief that it would make them whole again. One reviewer quipped about the study’s result with the tagline, “I have stuff, therefore I am.” According to Lerner, “Another tempting belief is that one’s mood (positive vs. negative), if it matters at all, would necessarily influence decisions in a mood-congruent way.
Sadness is a negative state but it does not trigger a negative outlook; instead it triggers increased valuation of commodities. People pay more to get things when they are sad.”
that angry decision makers have a difficult time being angry at the right time, for the right purpose, and in the right way, which hinders their ability to rationally enter a situation with objectivity. Instead, they make their decision with the tendency to feel confident, in control, and thinking the worst of others. These decisions often result in undesirable outcomes, such as aggression, unrealistic optimism, and overconfidence; however, in other situations, these decisions may result in desirable outcomes, inasmuch as anger can protect decision makers from indecision, risk aversion, and overanalysis. This too derives from the sense of certainty associated with anger, but may also be caused by a sense of optimism about the future.