This Is Your Brain on Money

Reprinted from Barron’s, September 3, 2007. Page 40.
This Is Your Brain on Money

Inside the Investor’s Brain
By Richard L. Peterson
392 Pages, $60

Reviewed by David L. Nathan, MD

IF YOU READ BARRON’S, AND APPARENTLY you do, read this book. Exceptionally well-written, it will likely prove to be a seminal text on the influence of the human brain on investment behavior. And neurofinance, as that field is known, may provide the next great edge for savvy investors.

The basic premise is that the structure and function of the human brain can be applied to the understanding of investment behavior. While our approach to buying and selling financial instruments may be basically rational, we make cognitive mistakes and possess emotional biases that can compromise our decision-making with disastrous results.

Before you flip this page to avoid reading about psychobabble, know that the author’s target audience is investors who possess nothing more than a pedestrian knowledge of psychology and neurology.

He speaks to you about the subtle workings of your brain with an exceptional level of authority and clarity. He points out which passages uninterested readers can afford to miss, and he wisely concedes that his explanations are incomplete, as “nothing is simple in neuroscience.”

Early on Peterson cites the failures of Sir Isaac Newton and Mark Twain, both brilliant men who made fundamental mistakes with their investments. They stuck with “losers” too long, and they didn’t keep to their own prearranged plans. What went wrong? The book addresses this and related questions by looking at the effects of emotional and intellectual biases.

The author, a psychiatrist and a consultant to financial firms, asserts that emotional intelligence is more important in business than raw intellectual power. While emotion is “messy,” it is central to all decision-making. Peterson addresses how inevitable positive and negative emotions can influence investing behavior, and quotes liberally from the likes of Warren Buffett and Jim Leitner to show how mastery of emotions can make for wiser buying and selling choices.

In a section that deals with rationality and cognitive distortions, Peterson covers a variety of errors in logic that investors tend to make. Some of the concepts may be familiar to those educated in business or psychology, though this presentation is a good refresher on critical theories. My father taught me that “psychology is just common sense,” but the utility of these principles, applied properly, is uncommonly sensible.

What can save us from ourselves? The answer is “neuroplasticity.” While sounding like advice from The Graduate, this is really just the trade term for the ability to learn. If we can learn from our mistakes, understand our quirky use of logic, and realize what pushes our buttons, improved decision-making will inevitably follow.

Inside the Investor’s Brain, written by an experienced but surprisingly young author (he’s 35), is outstanding. Peterson and his first book have much to offer investors and the institutions in which they work.

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