Don’t let your emotional brain control investment decisions. That’s the advice imparted today by economist Terry Burnham, author of Mean Markets and Lizard Brains, during a luncheon presentation to the Toronto CFA Society at the National Club in Toronto.
Burnham asserts that all human decisions, including those of investors, result from some level of conflict between two parts of the human brain: the analytical and the emotional, or “lizard”, brain.
During this current period of intense market volatility, Burnham’s words have particular applicability as investors attempt to make sense of mad markets. “Today is a dangerous time for the lizard brain. Psychological beliefs are colliding with economic truths,” he said in today’s presentation.
According to Burnham, all people have lizard brains. “These voices are powerful, hidden and impossible to silence,” he said.
But that doesn’t mean that investors must listen to the lizard brain. Burnham is adamant that while the emotional part of the brain cannot be shut off, it must be ignored when it comes to investing.
As an example, he cites a study that looked at the trades of 10,000 online brokerage investors, who didn’t use advisors. If an investor sold one stock and bought another within two days, both the stocks were tracked for a full 12 months after the trade occurred. On average, it turned out these unadvised trades lost an average of 340 basis points, not including fees and taxes.
Advisors, in Burnham’s experience, are susceptible to the power of the lizard brain in their own lives, but when it comes to other people’s money, he said, they tend to let the analytical brain take over.
When it comes to making market predictions, Burnham says his forecast is “gloomy.” Essentially, he expects all returns — bonds, T-bills, equities — to be lower in the coming years.
In today’s presentation, Burnham provided data on real investment returns over the last 125 years. Between 1880 and 2005, U.S. equity returns averaged 8%, according to his data. But between 2005 and this morning, they averaged 1.8% (the data included all Dow stocks, including dividends).
He calls the current financial environment “kryptonite” for the lizard brain and advises investors to avoid short-term information (“it’s like crack”) whenever possible. Avoid online trading and build in delays to your investment decisions, he says.
In Mean Markets, Burnham advises investors to reduce financial risk to a level far below one of comfort. He says the last 20 years of unsustainable gains have lulled investors into a perpetual state of optimism. He lists eight steps for investors to reducing risk in a portfolio:
- Allocate more money to lower-risk assets;
- Buy some inflation and deflation protection;
- Buy short-term bonds;
- Live in a smaller house;
- Have a fixed-rate mortgage;
- Invest in other currencies;
- Pay off your debts;
- Seek a secure paycheck.
In response to an audience question about “paralysis by analysis,” Burnham notes that in some cases it is possible — although rare –to train the lizard brain. He cites exceptional athletes as an example of successful instinctual behaviour, and also points to some of the ideas outlined by Malcolm Gladwell in his book Blink. “Some people are very good at short-term trading,” he says.
In general, Burnham’s advice about irrational investing is simply don’t do it. “Don’t trade or invest with your lizard brain,” he concludes.
“Because our instincts are exactly out of sync with financial opportunity, markets can be mean,” he says. “Markets can be mean to investors who buy when excited and sell when afraid.”
Burnham was an economics professor at Harvard University for many years. Before joining the Harvard faculty, he was the president and chief financial officer of the biotechnology firm, Progenics Pharmaceuticals, and worked on Wall Street for Goldman, Sachs & Co.
He has a PhD in Business Economics from Harvard University, master’s degrees from MIT and San Diego State University, and a BS in biophysics from the University of Michigan.