Have you ever wondered how Warren Buffett and other highly successful investors almost always makes the right decision when it comes to making money? Were they born differently, maybe their brain is simply wired to pick the best stocks at the right time. Ever since I started investing several years back, I've always wondered if I was born to do well controlling my investments such as stocks or bonds. This has led to me try and read as much as I can about how our brain can affect our investment performance.
There have been extensive studies on brain hemispheric dominance. A right brain dominant person tend to be "big picture" oriented as well as rely a bit more on feelings and hunches. 
On the other hand, left-brain people are detailed oriented and tries to follow logical, step by step thinking process. There are many tests online to determine which part of your brain is dominant (see links below). An interesting test is this animated image of a ballerina doing a pirouette (click on image to see full size). A right brain dominant person is supposed to see the ballerina rotating clockwise, while a left brain person should see it turning the other direction (counter-clockwise). My initial thoughts lean towards left-brain thinkers would make the better investors, but according to a study at Dartmouth which tested split-brain patients (those that can't process visual info on both sides of the brain at the same time), visual signals that can only be processed by the right brain hemisphere did 20% better forecasting a random event than those that can only be processed with the left. The test involved showing a random sequence of lights that had 80% one color and 20% the other color. The reason the left-brain tests fared much worse is because even though they knew the sequence was random, the patients still split their guess almost the same ratio of 80% one color and 20% the other color, even though the sequence was totally random. The right brain visual test resulted with the patients guessing only one color since he realized that he's guaranteed to get 80% correctly, incidentally a rat or a pigeon would do the exact same thing. Could this be an indicator why only about 15% of active fund managers actually do beat the market?
It is also common knowledge that one should never let his emotions dictate his investment decisions. This has definitely helped proliferate stock screens and other mechanical investment tools. If this is absolutely true, then it somewhat goes against the study regarding the split brain patients. Some studies have actually attributed above average skill such as in math, to the well developed bridge between the two brain hemispheres. The corpus callosum is the conduit between the two sides of the brain and tests on math prodigies indicates that their skill is a result of processing on both sides of the brain. On a side note, left-handed persons have been observed to have larger corpus callosum and are overrepresented among the above average math students. A book titled "The Tao Jones Averages" also notes that most highly successful people are those that have a balance between the right and left sides.
There are many articles written by Jason Zweig who authored the book called "Your Money and Your Brain". However, most of his studies seems to be how to avoid the common mistakes our brain tricks us into doing. One catchy expression he has coined is "prediction addiction". Simply put, because of humans' amazing ability to detect patterns, even with a random set of data, we tend to try to find any meaningful sequence and then predict the outcome. If the stock market activity, at least on the short-term, is very much random, our brain would still attempt to find something meaningful in the market volatility and then make a prediction for the outcome. If in the event we guess the outcome correctly, we fool ourselves into believing we deciphered the market activity rather than attribute this to pure chance and luck. In a recent interview on the Index Investing Show, Zweig talks extensively about emotions and how it can adversely affect your portfolio. In the same line of thought, he writes in his book "only fools invest without rules", which indirectly addresses the emotional factors telling us investors to follow our rules and not emotions.
Another interesting trait the brain has is described by the prospect theory or "loss-aversion". This theory shows how people are more willing to take risk when faced with a possible loss compared to taking the same amount of risk to achieve a possible gain. This might explain why quite a few investors have the tendency to hold on to losing positions longer than selling winning positions. Again, just like the emotional trap, this loss-aversion investing flaw can be overcome by adhering strictly to some kind of investing guidelines or rules.
A new field of study called neurofinance or neuroeconomics has recently been started to study how our minds help form economic decisions. But because of its fairly early stage of research, known facts on relations between neuroscience and financial decision are still limited. The possibility of neuroscans to screen potential high company positions such as CEOs has been raised, but obviously this faces a lot of ethical issues. For now, here are some tips on how to avoid common mistakes our brain makes when investing. The personal impression these studies have left me can be summarized as follows:
- Have some set of rules or guidelines for your investment portfolio, AND STICK WITH IT.
- Keep a complete journal or score for your performance to keep track of your accuracy. Our emotions can fool us into remembering our successes and forgetting mistakes.
- Mechanical stock screens might help avoid the pitfalls of the brain - AGAIN AS LONG AS WE STICK WITH IT.
LINKS:
The Trouble With Humans Why rats and pigeons might make better investors than people do
Is your brain wired for wealth?
A Smarter Brain
Left Brain/Right Brain Tests
Brain Hemispheric Consensus and the Quality of Investment Decisions.
Neuroeconomics: How Neuroscience Can Inform Economics
On Money, Risk and the Brain
The Working Money
