Believe it or not, people with certain kinds of brain damage may make better investment decisions. That is the conclusion of a study conducted back in 2005 by a team of researchers from Carnegie Mellon University, the Stanford Graduate School of Business and the University of Iowa.1 The study linked brain science to investment behavior and offered some compelling evidence that people with an impaired ability to experience emotions could actually make better financial decisions than other people under certain circumstances. The participants with brain-damage outperformed other people in an investment game and finished the game with an average of 13% more money than the other players.
The brain-damaged participants had normal IQ’s and the areas of the brain associated with logic and cognitive reasoning were intact. The region of the brain that controls emotions, however, contained lesions that inhibited their ability to experience emotions such as fear and anxiety. The study suggested that this lack of emotional responsiveness actually gave them and advantage when they played a simple investment game. The rules were very basic: Participants each got $20 they could use to place $1 bets on 20 tosses of an ordinary coin. Each losing bet would cost $1, while each winning bet would earn $2.50. From a cool-headed distance, the right decision is a no-brainer: Given the payout and the odds of winning, of course you should bet every time. But anyone at all familiar with behavioral economics knows that’s not what most people actually do. Irrationally, we are risk averse, finding the pain of loss much greater than the pleasure of equivalent gain. And, sure enough, the healthy participants passed up several chances to place a bet—and, as fear mounted with each subsequent coin toss, were less and less likely to take the gamble. As a result, they earned an average of only $22.80. The unemotional brain-damaged patients earned $25.70, on average, because they remained unswayed by the fear of loss throughout the game.
Clearly, successful investing involves a certain degree of emotional control. Unfortunately, emotions are part of our lives and many people find it very difficult to take an unemotional approach to investing. As an investment adviser I have observed firsthand how emotions can cloud someone’s investment sense. I truly believe that one of my most important jobs as an adviser is to protect people from themselves and not allow clients to be their own worst enemies when it comes to reaching their financial goals. I take great pride in the research I conduct to select appropriate investments for clients. However, I have to conclude that an investor’s portfolio return is far more dependent on the investor’s behavior than on the performance of the funds in their portfolio.
- Wall Street Journal, July 21, 2005
Damien helps individuals invest and manage risk. He is a Certified Financial Planner™ professional and a principal of Walnut Creek Wealth Management. These are the views of Damien Couture, CFP® and not intended as investment advice. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or Damien@WalnutCreekWealth.com.
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