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So a fair question is whether I™ve taken my own advice. The answer is
not completely. In spite of truly believing that the low-risk approach is
the way to go, I still have 10% of my money invested in stocks, including
some high-flying Internet stocks. Why? 10% in stocks is the lowest
amount of risk that I can take emotionally at this time.
A small risky investment is my effort to calm the lizard brain. During
my entire investing life, risky investments have paid the highest return.
Thus, my lizard brain constantly goes back to those heady days when
there was easy money to be made. Although I™m using my prefrontal cor-
tex to restrain the lizard brain, 10% is the lowest amount of risk that I can
stomach these days.
The acid test of an investment strategy is how one feels when the strat-
egy isn™t working. When the stock market is soaring, and my low-risk
investments are earning close to zero, my lizard brain screams, you fool!
282 Profiting from the New Science of Irrationality

Buy stocks! On those days, I need to have some money invested in stocks
or the lizard brain will break out of its cage and buy risk at precisely the
wrong time.
Take as little risk as you can stand. This is precisely the opposite of the
mainstream advice grounded in the view that markets are efficient. In the
fantasy world of efficient markets, we should take as much risk as we can
stand in order to get those high stock market returns. In the real world of
today™s mean markets, perhaps we should take as little risk as we can

Profiting from Manias and Crashes

The Mean Markets and Lizard Brains analysis suggests that we are in the
midst of a new sort of bubble. While stocks, bonds, and real estate do not
appear to be in bubble mode individually, the bubble may be in risk-
taking itself. A generation of reward for taking financial risk has pushed
us to take too many costly gambles.
The Mean Markets and Lizard Brains conclusion is that most people
should reduce their level of financial risk. Our lizard brains have extrap-
olated from a golden generation that rewarded risk, and pushed us toward
the risky investments that worked so well for so long. Unless productiv-
ity from the information revolution saves us, these risky investments are
likely to disappoint.
Thus, the Mean Markets and Lizard Brains prescription is to reduce
financial risk in order to be prepared for future opportunities. This advice
is, of course, tempered and customized by individual circumstance and
If humans were the rational, cool-headed robots of economic theory,
then achieving our financial goals would be easy. Because we are exactly
the opposite”emotional beings subject to bouts of irrational moods and
crazy decisions”financial success is difficult. In particular, in several
keys areas we need to lean into our human nature in order to profit from
financial opportunity.
Timely Advice 283

Four Keys to Profiting from Mean Markets

1. Be Different
A key to making money is to buy when others are selling and sell when
others are buying. In other words, in order to make money we have to do
the unpopular behavior that others aren™t doing.
Running against the mob is difficult because we are built to want to do
what others are doing”we want to be part of the group. One study found
that social isolation creates pain. In the study, three people played a ball-
tossing game on a computer screen while one sits inside a brain scanner.
The person in the brain scanner is told that the two other players are real
people, but they are actually fake people controlled by the experimenter.
The experiment looked at the brain in two conditions, being part of the
group or being ostracized. In the first, the real person is part of the game
and gets the virtual ball frequently. In the second, the two artificial players
exclude the real person by passing the ball back and forth.
Social isolation produced pain in these people. In fact, the brain scan
revealed the same electrical pattern as physical pain.6 So when we act dif-
ferently from others we have to overcome our human desire to be part of
the group.
This same study showed another interesting pattern. Those people
who employed their cognitive abilities more, felt less pain. To be precise,
the people who had higher levels of brain activation in the prefrontal cor-
tex had lower levels of activation in the pain centers. As is one of the
main themes of this book, success requires using cognition to control the
lizard brain.

2. Make the Investment Moves That
Do Not Produce Dopamine
Another key to making money is buying investments that have not done
well and selling those that have done well. As humans, we still share the
“do-it-again” brain centers with other animals. As B.F. Skinner made
famous, animals, including humans, tend to repeat behaviors that were
284 Profiting from the New Science of Irrationality

rewarded. Thus, Skinner™s stimulus-response system leads us to love the
investments that have made us money and hate the investments that have
lost us money.
Our brains are actually bathed in pleasure-causing dopamine when we
take the actions that have worked before. Spencer Johnson and Kenneth
Blanchard captured the essence of this in their bestseller Who Moved My
Cheese? In a world without change, the best way to find cheese is to
return to the location where it was found previously. In a world with
change, however, the best way to find cheese is to look somewhere new.
Financial markets are the worst environments in which to use stimu-
lus-response processes. Precisely because most people fall in love with
past winners, they tend to buy the investments that have gone up, not the
ones that will go up. Thus, to make the correct financial decisions, we
need to do exactly the opposite of what has been giving us our emotional
reward. To make money, we need to break the dopamine addiction (at
least in this area of our lives), and use our cognitive ability to control our
Those who want to follow the Mean Markets and Lizard Brains advice
to reduce financial risk will have to do precisely the opposite of what has
worked well for a generation.

3. Make an Emotionally Realistic Financial Plan
A third key to making money is to understand our own limits and to make
a financial plan that we can execute.
In Plato™s Apology of Socrates, the oracle of Delphi says that Socrates
is the “wisest of men.” Socrates is aware of his own flaws and so asks,
“How can this be?” After a conversation with a man widely deemed to be
brilliant, Socrates concludes, “I do not suppose that either of us knows
anything really beautiful and good, I am better off than he is, for he knows
nothing, and thinks that he knows; I neither know nor think that I know.”
Socrates is the wisest of men, Plato suggests, precisely because he is
aware of his flaws. Similarly, successful investors must be aware of their
own irrationality.
Timely Advice 285

In some unusual circumstances, people sometimes execute the perfect
financial plan. For example, in 1987, a Massachusetts man (who wishes
to remain anonymous) bought 1,000 shares of EMC for $15.75 a share.
He held on to the shares for 13 years, by which time they had become
48,000 shares (because of splits) each worth more than $100.00.7
For 13 years, this investor patiently rode his profits and converted
$16,000 into almost $5 million. In contrast, most investors make the mis-
take of harvesting their profits too quickly and riding their losses.
Even great investors tend to sell their winners too soon and to never
sell their losers. In the 1940 investment classic Where are the Customers™
Yachts? Fred Schwed, Jr. writes, “When a great and sagacious financier
dies, and the executors go through the strongbox, they usually find,
tucked well away in the back, bundles of the most hopeless securities
whose very names have been long since forgotten.”8
So how did our EMC holder resist the temptation to take profits? He
simply forgot that he owned the stock! He originally bought 3,000 shares
and sold 2,000. He didn™t know that he owned any shares until he was
notified by a state agency about his “inactivity.”
Unless we can similarly forget about our investments, we have to antic-
ipate our weaknesses. A frequent problem is that an investor has a “per-
fect” plan, but then makes an emotional trade at precisely the wrong time.
Thus, in my low-risk financial plan, I keep enough money invested in
stocks to stave off the lizard brain. Each person has to craft a customized
financial plan that anticipates and preempts moments of irrationality.

4. Be Tough Enough to Stick to a Plan
When I was in middle school, my friend Paul ran the 600-yard run (the
longest event) in the school™s annual athletic competition. Opposing him
was Jimmy, one of the bullies and part of the in-crowd. My friends and I
desperately wanted Paul to win, and we gathered round him minutes
before the start.
Paul knew that the race had implications for all his friends and for the
school™s entire social order. He spoke to us in a serious and calm manner.
286 Profiting from the New Science of Irrationality

Here™s what he said: “I don™t want you to get nervous if I™m behind in the
beginning, my strategy is to come from behind. Don™t worry, I™m going
to win.”
The race was three laps and”as Paul had forewarned”after one lap
he appeared hopelessly behind. Confident in his certain victory, Jimmy
started celebrating and gesturing to his fellow bullies in the crowd. On
the final lap, Paul accelerated and easily passed a tired Jimmy.
John Maynard Keynes remarked that markets tend to stay irrational for
longer than an investor can stay solvent. Therefore the investor who seeks
to profit from irrationality has to anticipate being behind in the race for a
long time. The goal, of course, is to have more money in the long run, not
to be in the “lead” for a while.
Even the legendary Warren Buffett had to endure scorn during the late
1990s because he refused to buy bubble stocks. Buffett avoided over-
priced stocks, which became even more overpriced before the bubble
popped. Accordingly, he missed out on the ephemeral gains and many
claimed that Buffet had “lost his mojo.” Buffet™s exceptional mental
toughness allowed him to persist and prosper. Unlike most people, he
never deviated from his plan.

Tame the Lizard Brain and Convert Mean
Markets into Opportunity

Taming the lizard brain by following the Mean Markets and Lizard
Brains advice is not easy. Quite to the contrary, it is very hard. The fact
that making money is difficult is precisely what makes it possible. If it
were easy to make money from others™ irrationality, then the opportuni-
ties would vanish.
Interestingly, financial success does not require fancy mathematical
skills or genius level IQ. No, it requires something far more rare and dif-
ficult. To make money investors need what Dan Goleman labels emo-
tional intelligence (EQ):
Timely Advice 287

EQ is not destiny”emotional intelligence is a different way of
being smart. It includes knowing your feelings and using them to
make good decisions; managing your feelings well; motivating
yourself with zeal and persistence; maintaining hope in the face
of frustration; exhibiting empathy and compassion; interacting
smoothly; and managing your relationships effectively.9

Goleman argues that attaining one™s goals in life requires emotional
intelligence more than IQ. Similarly, successful investing requires the
extremely rare quality of EQ. To profit from market excesses requires
self-knowledge, self-confidence, endurance, and mental toughness. The
successful investor has to face ridicule and must live with underperfor-
mance for extended periods.
“Money won is twice as sweet as money earned,” said Paul Newman
to Tom Cruise in The Color of Money. Similarly, I find money gained
through savvy investing to be far sweeter than wage income.

Markets are irrational, and our backward-looking, pattern-seeking lizard
brains push us to lose money. Investors who let the lizard brain make
financial decisions tend to buy at market tops and sell at market lows.
Because our instincts are exactly out of sync with financial opportunity,
markets can be mean.
However, it is the very irrationality of markets that provides the oppor-
tunity to make sweet profits. Financial success is based on using emo-
tional intelligence to shackle the lizard brain. Fortunately EQ can be
increased by diligence, introspection, and discipline. Therefore, any
investor willing to work to understand and tame the lizard brain can
transform mean markets into money and satisfaction.

1. Johns Manville, www.johnsmanville.com.

Chapter 1 Introduction
1. Personal communication. See Chapter 7.
2. Leading Wall St. Firms™ Asset Allocation Recommendations (for 2004). Dow Jones
Newswires, December 31, 2003.
3. Investment Company Institute, www.ici.org, 2004 fact book, 88.
4. Federal Reserve Survey of Consumer Finances, www.federalreserve.gov.
5. Berkow, R., The Merck Manual of Medical Information: Home Edition (New York:
Pocket, 1999), 1303.
6. U.S. Food and Drug Administration. Aspirin for Reducing Your Risk of Heart Attack
and Stroke: know the facts. www.fda.gov.

Chapter 2 Crazy People
1. Those interested in more detail can see: Glimcher, P. W., Decisions, Uncertainty, and
The Brain: The Science of Neuroeconomics (Cambridge, Mass: MIT Press, 2003).
2. Medawar, P.B., An Unsolved Problem of Biology (London: H.K. Lewis, 1952), 3.
3. Harig, B., “Woods ˜Uncomfortable™ with His Game,” ESPN.com, April 26, 2004.
4. Tversky, A. and D. Kahneman, “Extensional versus Intuition Reasoning: Conjunc-
tion Fallacy in Probability Judgment,” Psychological Review, 90 (1983): 293“315.
5. Burrough, B. and J. Helyar, Barbarians at the Gate (New York: Harpercollins, 1990).
6. Burnham, T. and J. Phelan, Mean Genes (Cambridge: Perseus, 2000), 83“104.
7. Tversky, A. and D. Kahneman, “Evidential Impact of Base Rates,” Judgment under

290 Endnotes


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