In
Your Money and Your Brain: How the New Science of
Neuroeconomics
Can Help Make You Rich
(Simon & Schuster), author Jason Zweig, a senior writer at
Money
magazine, offers new explanations about what makes the investing brain a battleground between emotion and reason.
His book is not only an enlightening account of what goes on in the brain when you think about money but a practical guide on how investors can make wiser decisions.
We spoke with Zweig, now collaborating on a book with Nobel Prize-winning psychologist Daniel
Kahneman
, to learn the ways in which financial advisors can apply
neuroeconomics
in their practices.
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Can
neuroeconomics
help make advisors better investors?
It can certainly help you understand clients better. You can also use it as a mirror to ask yourself, “What am I actually good at?” Most people aren’t as good at most things as they believe they are. We all have an inner con man
who
lies to us about our past, our future and even the present.
How can
neuroeconomics
be used to help prevent investors’ hindsight bias — distorting that which you formerly believed?
Both advisors and clients are very vulnerable to hindsight bias, another cruel trick your inner con man plays on you. So once a year, have a little forecasting session with each client asking where they think the Dow will be a year from now, what the most promising stocks are, what they think the worst ones will be and so on. You should do a forecast as well.
A year later, when a client starts yelling [about a poorly performing stock], you can say, “Well, let’s look at what each of us forecast. You didn’t say anything about that particular stock.”
The client will still say, “It’s your job to know what’s going to happen.” But then you should say, “It’s my job to make forecasts about things that I think are
forecastable
. Which specific companies [will] outperform the market may not be one of them.”
Are advisors’ brains different from the brains of investors who aren’t professionals?
I’m very sad to say that I think they don’t differ. Overconfidence is probably the thing that trips up more people than anything else. It’s very hard for professionals who have real expertise to admit the limits of that expertise. Financial advisors may provide great advice on the mechanics of investing and financial planning, but I’m very skeptical that most advisors can add value by picking stocks or mutual funds.