Jason Zweig Quotes

The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The Intelligent Investor is a realist who sells to optimists and buys from pessimists.

The alluring, long-shot chance of a huge gain is the grease that lubricates the machine of innovation.

WHEN YOU INVEST, your mind has a mind of its own. At the very moment when you are most convinced of your own rationality, you may be feeling rather than thinking your way toward a decision.

What history does prove is that how risky stocks seem, and how risky they actually are, are inversely correlated.

Being right is the enemy of staying right because it leads you to forget the way the world works

Good advice rarely changes, while markets change constantly. The temptation to pander is almost irresistible. And while people need good advice, what they want is advice that sounds good.

That’s why one of my favorite investing rules is “If the market is open, your wallet should be closed.” You should never act on an investing idea the same day you get it; the next day, your mood and situation will have changed, and the facts may look different to you. Sleeping on it is one of the simplest and best ways to make sure your decision is not just a momentary whim.

The risk you are likely to be rewarded for taking is the risk of owning all stocks. In effect, rather than betting on one roll of the dice, one spin at the roulette wheel, or a single hand at the blackjack table, you can own the whole casino. You can do this effortlessly, cheaply, and reliably by buying a total stock-market index fund, a low-cost portfolio of all the stocks worth owning.

The Art of Subtraction If there is one habit that all of the investors in this chapter have in common, it’s this: They focus almost exclusively on what they’re best at and what matters most to them. Their success derives from this fierce insistence on concentrating deeply in a relatively narrow area while disregarding countless distractions that could interfere with their pursuit of excellence. Jason Zweig, an old friend who is a personal finance columnist at the Wall Street Journal and the editor of a revised edition of The Intelligent Investor, once wrote to me, “Think of Munger and Miller and Buffett: guys who just won’t spend a minute of time or an iota of mental energy doing or thinking about anything that doesn’t make them better. . . . Their skill is self-honesty. They don’t lie to themselves about what they are and aren’t good at. Being honest with yourself like that has to be part of the secret. It’s so hard and so painful to do, but so important.

Interviewed in 1999 by Jason Zweig, Aronson said, “Small-caps don’t outperform over time . . . Sure, the long-run numbers show small stocks returning roughly 1.2 percentage points more than large stocks . . . [But] the extra trading costs easily eat up the entire extra return—and then some!

A stock is not cheap or expensive merely because its price is below or above a particular number. It is cheap or expensive only in relation to the fundamental value of the underlying business, which has nothing to do with whether the share price is near an anchor. If you find yourself getting excited over any investment based purely on its price, you’re anchoring.

Every profession is a conspiracy against the laity, and every profession’s jargon is meant to confuse and exclude those who aren’t part of the guild.

You should welcome a bear market, since it puts stocks back on sale.

Making money feels good, all right; it just doesn’t feel as good as expecting to make money. In a cruel irony that has enormous implications for financial behavior, your investing brain comes equipped with a biological mechanism that is more aroused when you anticipate a profit than when you actually get one.

At the University of Iowa, students were briefly shown numbers that they had to memorize. Then they were offered the choice of either a fruit salad or a chocolate cake. When the number the students memorized was seven digits long, 63% of them chose the cake. When the number they were asked to remember had just two digits, however, 59% opted for the fruit salad. Our reflective brains know that the fruit salad is better for our health, but our reflexive brains crave that gooey, fattening chocolate cake. If the reflective brain is busy figuring something else out—like trying to remember a seven-digit number—then impulse can easily prevail. On the other hand, if we’re not thinking too hard about something else (with only a minor distraction like memorizing two digits), then the reflective system can overrule the emotional impulse of the reflexive side.

As Kahneman puts it, “The combination of optimism and overconfidence is one of the main forces that keep capitalism alive.

In the long run a stock has no life of its own; it is only an exchangeable piece of an underlying business. If that business becomes more profitable over the long term, it will become more valuable, and the price of its stock will go up in turn. It’s not uncommon for a stock’s price to change as often as a thousand times in a single trading day, but in the world of real commerce, the value of a business hardly changes at all on any given day. Business value changes over time, not all the time. Stocks are like weather, altering almost continuously and without warning; businesses are like climate, changing much more gradually and predictably.

Stocks are like weather, altering almost continuously and without warning; businesses are like climate, changing much more gradually and predictably.

In coming back to the lottery like a moth to the flame, Laurie Zink is typical: A survey of people who had won at least $1 million in the Ohio state lottery found that 82% kept buying lottery tickets on a regular basis after their windfall.

Likewise, in early 1999, the stock of Mannatech Inc. shot up 368% in its first two days of trading when Internet-crazed traders mistakenly thought Mannatech was a technology stock; in fact, it is a marketer of laxatives and nutritional supplements.

And once hordes of people like a company, it becomes what finance professor David Hirshleifer calls a “celebrity stock.” At that point, just like Kathie Lee Gifford or Mr. T, it is almost sure to end up overpriced, overexposed, and overdue for a collapse in popularity. No matter how great a business may be, its stock can’t be an enduring moneymaker once an investor stampede drives the price up too high. Thus, over the long run, familiarity breeds failure.

Hiroyuki Nakahara of the RIKEN Brain Science Institute in Wako, Japan, calls this early-warning flare “the anticipation of anticipation of reward.” It’s as if Pavlov’s dogs salivated not when the bell rang, but as soon as they saw Pavlov start walking toward the bell.

Remember, anybody can look like a genius when most investments are going up. As psychologist Daniel Kahneman quips, “In a rising market, enough of your bad ideas will pay off so that you’ll never learn that you should have fewer ideas.

In 1997, money manager David Leinweber wondered which statistics would have best predicted the performance of the U.S. stock market from 1981 through 1993. He sifted through thousands of publicly available numbers until he found one that had forecast U.S. stock returns with 75% accuracy: the total volume of butter produced each year in Bangladesh. Leinweber was able to improve the accuracy of his forecasting “model” by adding a couple of other variables, including the number of sheep in the United States. Abracadabra! He could now predict past stock returns with 99% accuracy. Leinweber meant his exercise as satire, but his point was serious: Financial marketers have such an immense volume of data to slice and dice that they can “prove” anything.

financial losses are processed in the same areas of the brain that respond to mortal danger;

But that kind of critical thinking is anathema to your intuition, which is most comfortable when dealing with the concrete reality of “what is.” To handle a conceptual abstraction like “what is not,” you need your reflective system to kick in with the hard mental effort of comparing alternatives and evaluating evidence. That requires asking tough questions like “under what conditions would this no longer be true or fail to work?” And the human mind, which functions as what psychologists Susan Fiske of Princeton and Shelley Taylor of UCLA have called a “cognitive miser,” tends to shy away from that kind of effort. If the reflective system can’t readily find a solution, the reflexive brain will resume control, using sensory and emotional cues as shortcuts. That’s why even professional statisticians failed to solve Hogarth and Einhorn’s task correctly: Why go through the trouble of trying to test the logic of all four answers when answer No. 1 feels and sounds so right at first blush?

But it’s the denominator that matters; that’s where the real money is. After all, the sum total of your wealth is a much more important number than the amount by which it rose or fell on any given day. Even so, many investors fixate on the numbers that change the most, overlooking the much larger amounts of money that are at stake overall.

We like to think that we’re ‘thinking’ when we estimate probabilities,” says Eric Johnson, a psychology professor at Columbia Business School, “but a surprisingly large portion of the process appears to occur automatically, below the level of consciousness.

So the possibility of loss makes the hope of gain even more tantalizing. If you think about it, this makes perfect sense. Evolution has naturally designed us to pay closer attention to rewards when they come surrounded by risks—just as we all know we need to be more careful when picking a rose than when picking a daisy.

These steps will help you remember that correlation is not causation, and that most market prophecies are based on coincidental patterns. That was the problem in the late 1990s at the Motley Fool website. Its Foolish Four portfolios were based on research claiming that factors like the ratio of a company’s dividend yield to the square root of its stock price could predict future outperformance. In the long run, however, a company’s stock can rise only if its underlying business earns more money.

The newest findings in neuroeconomics suggest that much of what we’ve been told about investing is wrong. In theory, the more we learn about our investments, and the harder we work at understanding them, the more money we will make. Economists have long insisted that investors know what they want, understand the tradeoff between risk and reward, and use information logically to pursue their goals. In practice, however, those assumptions often turn out to be dead wrong.

Neuroeconomics shows that you will get the best results when you harness your emotions, not when you strangle them.

During 1998 and 1999, one group of stocks outperformed the rest of the technology industry by a scorching 63 percentage points—merely by changing their official corporate names to include .com, .net, or Internet.

Among the most painful of the stock market’s many ironies is this: One of the clearest signals that you are wrong about an investment is having a hunch that you’re right about it. Often, the more convinced you are that your hunch will pay off big, the more money you are likely to lose.

In truth, the reflexive brain is not a single integrated system, but a jumble of structures and processes that tackle different problems in varying ways, everything from the “startle reflex” and pattern recognition to the perception of risk or reward and the character judgments about the people we meet. What these processes have in common, however, is that they tend to run rapidly, automatically, and below the level of consciousness.

According to money manager David Dreman, over the past thirty years the analysts’ estimate of what companies would earn in the next quarter has been wrong by an average of 41%. Imagine that the TV weatherman said it would be 60 degrees yesterday, and it turned out to be 35 degrees instead—also a 41% error (on the Fahrenheit scale). Now imagine that’s about as accurate as he ever gets. Would you keep listening to his forecasts?

The pursuit of patterns in random data is a fundamental function in our brains—so basic to human nature that our species should not be known only as Homo sapiens, or “man the wise.” We might better be named Homo formapetens, or “man the pattern-seeker.

The financial markets are almost—though not quite—as random as those flashing lights, and they vary in incredibly complex ways. Although no one has yet identified exactly where in the brain the interpreter is located, its existence helps explain why the “experts” keep trying to predict the unpredictable. Facing a constant, chaotic storm of data, these pundits refuse to admit that they can’t understand it. Instead, their interpreters drive them to believe they’ve identified patterns from which they can project the future.

The main difference between us and apes,” explains anthropologist Todd Preuss of Emory University, “seems to be less a matter of adding new areas [in the brain], and more a matter of enlarging existing areas and modifying their internal machinery to do new and different things. The ‘what if’ questions, the ‘what will happen when’ questions, the short-term and long-term consequences of doing X or Y—we have lots more of the brain where that kind of processing goes on.

It’s important to realize,” says Stanford’s Knutson, “that the magnitude of a long-shot reward is going to drive your behavior far more than the probabilities, which are minuscule. If you can recognize that, then you should be able to say to yourself, ‘I should walk away and play with my kids for an hour and then think about it.’” Making a financial decision while you’re inflamed by the prospects of a big gain is a terrible idea. Calm yourself down—if you don’t have kids to distract you, take a walk around the block or go to the gym—and reconsider when the heat of the moment has passed and your anticipation circuits have cooled off. So don’t just blink; think.

DON’T JUST PROVE; TRY TO DISPROVE. As we’ve seen, the reflexive brain believes that the best way to prove an assertion is to keep looking for more proof that it is true. But the only way to be more certain it’s true is to search harder for proof that it is false.

All this research, says Buffett, really points you back to one central issue: “My first question, and the last question, would be, ‘Do I understand the business?’ And by understand it, I mean have a reasonably good idea of what it will look like in five or ten years from an economic standpoint.” If you aren’t comfortable answering that basic question, you shouldn’t buy the stock.

The upshot: An early run of success makes people feel they suddenly have power over a purely random process. Instead of attributing the results to an abstract force like “chance,” they now believe in “luck,” a personal force that watches over them (at least temporarily) like a guardian angel. So long as luck seems to be lingering in the air, people feel compelled to make the most of it—and that can lead investors to take reckless amounts of risk.

Halfway through, however, the experiments secretly reversed the payoffs, so the deck that had originally been hot now was cold, and vice versa. Strikingly, the players that had tasted a hot streak could not recognize that the rules of the game had changed. “They don’t get it,” says Cal-Tech neuroscientist John Allman. “The people who’ve had the biggest gain have the hardest time reversing their choice. It’s as if their ability to correct errors has been anesthetized, and they have become addicted to the favorable outcome.

Once you understand that monetary gains have this narcotic power, it no longer seems surprising that people can get so carried away financially.

This “I-told-you-so” rant from your inner con man makes it hard to remember that he never told you any such thing. And conning yourself about Google may well make you more eager to take the plunge the next time you have a chance to get in on the ground floor of a risky high-tech start-up. Of course, “the next Google” may turn out to be the next Enron instead.

That’s the power of hindsight bias—yet another way in which your inner con man works at trying to make you feel smarter than you really are. By preventing you from learning the truth about the investing past, hindsight bias keeps you from getting a firm grip on the financial future.

The same ignorance of our own ignorance haunts our financial judgments. Among American workers who say they are “very confident” that they will have enough money to live comfortably in retirement, 22% are currently saving nothing for that goal, and 39% have saved less than $50,000. Another 37% have never even estimated how much money they will need to retire comfortably.

The German mathematician Karl Jacobi had useful advice: “Invert, always invert.” Explains the investor Charles Munger: “It is in the nature of things, as Jacobi knew, that many hard problems are best solved only when they are addressed backward.” If someone tells you that the odds of success are 90%, invert the frame like this: That means there’s a 10% chance of failure. Is that too high for you? Next, flip the percentage frame into a personal one: One out of every ten people who try this will fail. How do I know I won’t be the one?

One study looked at more than 94,000 estimates of quarterly earnings over roughly twenty years and found that they resulted in negative surprises more than 29,000 times. More than 1,250 times in 2005 alone, companies announced quarterly earnings that fell one penny per share short of what Wall Street expected. According to Numeric Investors L.P. of Cambridge, Massachusetts, the shares of these companies immediately fell by an average of 2%.

The amygdala helps focus your attention, in a flash, on anything that’s new, out of place, changing fast, or just plain scary. That helps explain why we overreact to rare but vivid risks. After all, in the presence of danger, he who hesitates is lost; a fraction of a second can make the difference between life and death.

Online stock traders often check their portfolios ten or twenty times an hour—as if, by not letting their stocks out of their sight for more than a few minutes, they could somehow keep their prices from dropping.

But Kandel’s safety-conditioned mice barge right out into the middle of open space when they hear those beeps that they’ve learned to associate with the absence of immediate danger. Boldly going where no mouse has gone before, they wander much farther afield in a bout of what Kandel calls “adventurous exploration.” What makes these mice turn lion-hearted? When safety-conditioned mice hear the series of beeps, neurons in the caudoputamen—a part of the mouse brain similar to our caudate area—go into overdrive, firing at nearly three times their normal intensity. At the same time, neurons in the amygdala—a fear center in the mouse brain, as it is in ours—quiet down. It’s as if the perception of safety leads to a feeling of mastery over the environment, numbing the brain’s ability to be afraid. No wonder investors take more risk when their own gains fool them into thinking the market has gotten safer.

Many 401(k) investors load up on their own company’s stock in the apparent belief that they can levitate it all by themselves. “When you own a significant number of shares, you want to work hard and make the company prosper so you can prosper,” said an employee of Global Crossing, the fiber-optic phone network, in 2001. (His hard work, unfortunately, did not keep Global Crossing from going bust and wiping out his retirement savings.)

control what you can and let go of everything else.

As neuroscientist Arne Öhman puts it, evolution has designed our emotions “to make us want to do what our ancestors had to do.

Economist Colin Camerer of the California Institute of Technology sums up the reflexive system this way: “It’s kind of like a guard dog. It makes rapid but sort of sloppy decisions. It will always attack the burglar, but sometimes it might attack the postman, too.” That’s why “blink” thinking can get investors into trouble.

A control group of people with undamaged brains readily learned to favor the forecaster whose predictions turned out to be most accurate. The prefrontal patients, however, made their judgments perceptually instead of conceptually, relying on what Grafman calls “cues that typically had nothing to do with a good choice.” One patient, for example, preferred the advisor whose image was displayed on a green background, “since it is springtime.” It seems that if the prefrontal cortex is impaired, the brain’s internal checks-and-balances system breaks down—and the reflexive areas may take over unopposed.

The single biggest step you can take to improve your investing results is to stare long and honestly into a mirror to see whether you really are the investor you think you are. Are you truly above average? Are your own decisions the main force that shapes your returns? Is “buying what you know” the best investment approach? Did you really predict where the market was going? Do you know as much as you think you do? The bad news is that, for most of us, the answer to most of these questions is No. The good news is that neuroeconomics can help you bring your confidence into synch with reality, making you a better investor than you may ever have imagined.

The only way to achieve everything you’re capable of is to accept what you are not capable of.

All this motion can be so distracting that Warren Buffett has said, “I always like to look at investments without knowing the price—because if you see the price, it automatically has some influence on you.

Being in the presence of familiar things (even when we are unaware of them) simply makes us feel better. “The repetition of an experience is intrinsically pleasurable,” says Zajonc. “It augments your mood, and that pleasure spills over anything which is in the vicinity.

Brain scans in Peter Kenning’s neuroeconomics lab at the University of Münster in Germany show that when investors consider putting money in foreign markets, the amygdala—one of the brain’s fear centers—kicks in. These findings suggest that keeping our money close to home generates an automatic feeling of comfort, while investing in unfamiliar stocks is inherently frightening. Those responses originate in the biological bedrock of the reflexive brain.

In the stock market, the shares that are most popular and familiar to investors change hands more often, and that, in turn, attracts still more attention to these stocks as they turn up in the day’s list of “most active shares.” Because of all that extra exposure, the stocks with the highest trading volume have higher returns in the short run—but, in the long term, they tend to underperform by two to five percentage points per year. In the stock market, which is a game of inches, that’s a country mile.

Hindsight bias makes surprises vanish,” says psychologist Daniel Kahneman. “People distort and misremember what they formerly believed. Our sense of how uncertain the world really is never fully develops, because after something happens, we greatly increase our judgments of how likely it was to happen.

Since no one really has a fixed tolerance for risk, says psychologist Paul Slovic, it’s more helpful to think in terms of “goals, objectives, and outcomes.” How much money will you need down the road? How will you get there? What kind of result do you want to attain—or want to avoid? To answer these questions, you need to know your budget, calculate your current assets, and plan your future income and expenses. While those numbers aren’t perfectly certain, either, they are a much more reliable basis for judgment than a squishy concept like “risk tolerance.

You don’t need to fall off a ten-story building in order to be afraid of falling off it,” says neuroscientist Antoine Bechara of the University of Southern California. “Your brain doesn’t need actual experience.

Equivalent ways of describing something should lead to equivalent judgments and decisions,” says University of Oregon psychologist Paul Slovic. “But it’s not true. People’s judgments about risk are very moveable and subjective.” When you face a chance to make or lose money, your decision can be pulled one way or another like a lump of Silly Putty just by a minor change in context or description—what psychologists call framing.

study asked more than 400 doctors whether they would prefer radiation or surgery if they became cancer patients themselves. Among the physicians who were informed that 10 out of 100 patients would die from surgery, half said they would prefer to be treated with radiation. Among those who were told that 90 out of 100 patients would survive surgery, only 16% said they would choose radiation.

Because the alternative frames play so differently on our feelings, we don’t even notice that all four programs are equivalent.

When a choice is framed positively, as a potential gain, it’s as if the glass is partly full. And that seems like an improvement over the empty glass we started with, so our instinct is to preserve what we’ve gained.

Framing can lead to other freaky decisions. Imagine that you have $2,000 in the bank. I offer you a choice: Do nothing, or take a 50/50 chance of either losing $300 or winning $500. Would you stand pat or take the gamble? Think about it for a second. Now imagine, again, that you have $2,000 in the bank. Now I offer you this choice: Do nothing, or take a 50/50 chance of ending up with either $1,700 or $2,500. Would you stand pat or take the gamble? Most people reject the first gamble but take the second one. That’s because the first is framed to stress the amount you will gain or lose relative to what you started out with, while the second is framed to emphasize the total amount you end up with. The change feels bigger—and potentially scarier—in the first frame, so most people turn it down. The two gambles are economically identical. Psychologically, they are worlds apart.

You will be far more inclined to take a risk if you’re told that the odds of success are 1 in 6 than if you’re told there’s a 16% chance of succeeding. If you’re told there’s an 84% chance of failing, you probably won’t touch it.

The idea of saving 200 people in Program A is literally a “no-brainer,” says Gonzales. Because Program A is framed as a sure gain, “it’s a simple alternative that can be evaluated at very low cognitive cost,” she explains. And this frame suggests no emotional cost, since it calls your attention to the lives saved rather than the lives lost. You can see how little effort the brain takes to evaluate this choice in the top left of Figure 6.1. On the other hand, when a risk is framed negatively—for instance, by stressing those 400 lost lives—then it incites images and ignites emotions. The thought of losing money, like losing lives, is so inherently alarming that it ends up triggering intense activation in an area of your brain called the intraparietal sulcus. This curving wrinkle of tissue, located toward the top of your head behind your ears, appears to function somewhat like a mental movie screen. It enables you to visualize and imagine the consequences of actions not yet taken. The more uncertain the consequences are, the more active the intraparietal sulcus becomes.

When we make decisions,” explains Gonzalez, “we balance how much we need to think about an alternative against how much we stand to lose.” When your brain has to work this hard, it’s the emotional stakes that tip the balance. Even a slight chance that no one will die feels better than the certainty that most people will die. That’s why we pick Program D: Emotionally, it’s the easy way out.

When psychiatrists were told that “patients similar to Mr. Jones are estimated to have a 20% chance of committing an act of violence” within six months, 79% were willing to release Mr. Jones from a mental hospital. But when they heard that “20 out of every 100 patients similar to Mr. Jones are estimated to commit an act of violence” in the same period, only 59% said they would let him out—even though the odds that he might hurt somebody were identical.

So a financial advisor can goad you into taking (or avoiding) an investment risk just by changing how he describes it. If he boots up some fancy software that says you have a 78% chance of meeting your retirement goals, that sounds great. But he can reframe the same result and strike fear into your heart by declaring that “22 out of 100 people with your strategy will end up eating cat food in the dark”—and the next thing you know, he has foisted a bunch of risky stocks onto you that you never wanted.

As the study of doctors considering cancer treatment showed, experts can fall prey to framing problems just as easily as amateurs can. Whether you are a retail investor or a professional money manager, your “risk tolerance” is supposed to be an integral part of your personality. But it can be transformed by an embarrassingly basic twist in wording. That’s why every investor must be eternally vigilant against the dangers of getting framed.

When institutions own a hot stock in a trendy industry, they usually have heard of it by word of mouth rather than through original research—and they go on to talk it up with three times as many colleagues as the owners of less exciting stocks do. No wonder “everybody” often seems to be talking about the same stock.

Informational cascades are not necessarily irrational. If you really don’t know much about automobiles, you should try to figure out who does and take your cue from them, especially when you have to make a decision on the spot and have no time to learn more on your own. It’s a simple guideline for making simple choices when you know you don’t have all the information you need.

Animals seem more inclined to let others do some of their thinking for them when their own information is incomplete, outdated, or if they feel vulnerable.

Explains psychologist Mauricio Delgado: “Being in control—or at least believing that we are—makes us that much more invested in our actions and their consequences.

Researchers at the University of Wisconsin have shown that imagining you are in control of a situation—even when it is entirely out of your hands—can reduce the neural activity in areas of your brain that process pain, anxiety, and conflict. By helping to dampen your brain’s distress network, the illusion of control can create actual comfort.

Let’s say, for example, that you figure you’re 25% better than average at picking stocks, and you think you can earn 15% a year on your portfolio. That sounds realistic enough—until you consider the third question. The long-term average annual return on the Standard & Poor’s 500 index of blue-chip stocks is 10.4%. If, however, you adjust that number for the cash that people added to and subtracted from their portfolios, the average return drops to just 8.6% annually since 1926. Factor in taxes, trading costs, and inflation, and the annual return of the typical investor drops below 4%. If you really are 25% better than average, you shouldn’t expect to earn much more than 5% annually after all your costs. You still might be able to earn 15% a year—if you are at least three times better than average. Only by asking all three questions can you tell just how crazy your inner con man is.

We all know that the glass seems either half empty or half full depending on how we feel about ourselves. But it also depends on how we feel about the glass. Researchers have shown that when a four-ounce glass has two ounces of water poured out of it, 69% of people will say it is now “half empty.” If the same glass starts out empty and then has two ounces of water poured into it, 88% of people will now say it is “half full.” There’s no difference in the size of the glass or the amount of water, but a simple twist of context changes everything.

If you find it hard to imagine stepping outside yourself, try an exercise anyone can relate to. Before concluding that an investment decision is right for you, ask whether you’d be comfortable advising your mother to do the same thing. If you would tell her not to do it, then why should you do it? I call this the WWMD question (What Would Mom Do?).

The experience of a loss or a gain,” says Weber, “depends on what the loss or gain is relative to.” People, like animals, tend to evaluate how much the outcomes vary relative to the total amount of wealth that appears to be at stake. When that difference is high, people will gravitate away from the risky deck to the certain deck. (If the cards in one deck always pay $1, while in the other deck nine cards pay nothing and one pays $10, roughly 70% of people will prefer the “sure thing” of the first deck.)

It’s important to document your reasons for investing before you buy. Memory researcher Elizabeth Loftus has shown that your recall of how you felt earlier can be easily “contaminated” by what happens later. If you make your diary entry after the fact, your memory of your original motivation may be affected by any later changes in the price (“I bought it at $14 because I knew it would instantly go to $15”).

As Bobbi Bensman’s story shows, the conventional wisdom that every investor has a certain level of “risk tolerance” is little more than a lie. In reality, your perception of investment risk is in constant flux, depending on your memories of past experiences, whether you are alone or part of a group, how familiar and controllable the risk feels to you, how it is described, and what mood you happen to be in at the moment. The slightest change to any of these elements can turn you from a raging bull to a cowardly bear in a matter of seconds.

In a lab at the University of Puerto Rico, little birds called bananaquits were offered a choice between yellow flowers, which always held 10 milliliters of nectar, and red flowers containing amounts between zero and 90 milliliters. The wider the range of reward in the red flowers, the more the birds preferred the constant payoff in the yellow flowers.

A little knowledge really is a dangerous thing: Learning even a tiny bit about something fills us with a sense of power, and that feeling would be intensely threatened if we admitted how much more we don’t know. That’s why it takes so much confidence to admit that you aren’t confident; three of the hardest words in the world to say are “I don’t

there are very few certainties in the financial markets, and your investing brain is designed to exaggerate your abilities, favor the familiar, and imagine far more mastery over the past and future than you may ever have.

While vivid sights and sounds fire up the emotions in your reflexive brain, the more complex cues of language activate the prefrontal cortex and other areas of your reflective brain. By using words to counteract the stream of images the markets throw at you, you can put the hottest risks in cooler perspective.

As we’ve learned, if you view a photograph of a scary face your amygdala will flare up, setting your heart racing, your breath quickening, your palms sweating. But if you view the same photo of a scary face accompanied by words like angry or afraid, activation in the amygdala is stifled and your body’s alarm responses are reined in. As the prefrontal cortex goes to work trying to decide how accurately the word describes the situation, it overrides your original reflex of fear.

Experiments with monkeys have shown that when the odds of earning a reward are around 50/50, neurons deep in their brains emit a surge of dopamine that steadily escalates for nearly two seconds. Rewards that are highly certain trigger a much shorter, flatter response. The extra excitement that an “even gamble” generates in the dopamine system may be nature’s way of getting us off the fence.

How much money you made or lost on your last investments can transform how risky you think the next one is. The same bet can feel either dangerous or safe, depending on whether you are on a hot streak or in a slump. That’s how your investing brain is designed. Animals that are running low on food, water, or warmth have what ecologists call a “negative energy budget.” Creatures that are hungry, thirsty, or cold can rarely afford to take the chance that small but steady gains will be enough to keep them alive. In effect, they need to try striking it rich. So animals in a state of deprivation tend to prefer more variable rewards: While that raises the risk of getting nothing, it’s also the only feasible way to get the big boost they need to restore their depleted energy.

If you unquestioningly trust your intuitive perceptions of risk, you will chronically take gambles you should avoid and back away from bets you should embrace.

All journalists stand on the shoulders of giants, whether they admit it or not. In many cases, my book was vastly enhanced by the superlative work of other journalists, writers, and financial historians, who have themselves explored some of the subjects and themes I have tried to knit together in one sweeping narrative. Peter Bernstein is a huge inspiration, and his books were of tremendous help for some of the earlier chapters, as was Colin Read’s The Efficient Market Hypothesists. Lewis Braham’s biography of Jack Bogle is essential reading for anyone interested in the tumultuous life of Vanguard’s founder. Ralph Lehman’s The Elusive Trade was exhaustively detailed on the genesis of ETFs, and Anthony Bianco’s The Big Lie vividly tells the story of WFIA/BGI in the Pattie Dunn era. I have also learned an enormous amount from working with or admiring from afar financial journalists like John Authers, Gillian Tett, James Mackintosh, Philip Coggan, and Jason Zweig, as well as industry experts such as Deborah Fuhr, Ben Johnson, Eric Balchunas, and David Nadig. They are all titans upon whose shoulders I nervously perch.

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Jason Zweig, senior writer and columnist at Money magazine and coauthor of the revised edition of Benjamin Graham's classic, The Intelligent Investor: "If you buy-and then hold-a total stock market index fund, it is mathematically certain that you will outperform the vast majority of all other investors in the long run. Graham praised index funds as the best choice for individual investors, as does Warren Buffett.