COMMENT
Invest Like A Psychopath

By David Kuo (TMFDragon)
September 19, 2005

A group of eminent American academics suggests that "functional psychopaths" tend to be better stock market investors. Researchers from Stanford Graduate School of Business, Carnegie Mellon University and the University of Iowa concluded that people with brain damage that caused them to suppress emotions significantly outperformed those with fully functioning feelings.

The boffins found that emotions can make "normal" investors play it too safe. In contrast they found that the emotionally impaired are more willing to gamble for high stakes.

Their study was based on a twenty-round gambling game, where participants were given $20 to play with at the outset. At each round, they were asked if they wanted to risk $1 on the toss of a coin. If they won, they received $2.50, but they lost their stake if they guessed wrong.

In theory, with a 50-50 chance of winning, the expected return of playing each round was $1.25. However, the expected return of not playing was just $1. Consequently, from a logical standpoint the right thing to do was to invest in every round.

The researchers found that initially all the players would invest their dollar rather than stay on the sidelines. But as the rounds progressed, "normal" participants would grow cautious and were more concerned about conserving their winnings. However, those with "brain damage" did not, and ended up with an average of $25.70 almost $3 more than the "normal group".

Through additional analysis, the academics discovered that "normal" individuals were reacting emotionally to the outcome of the previous round. So, if they lost money they became scared and tended to back off and declined to play further.

So, what does this have to do with investing?

The academics said the study was especially relevant to a concept called the "equity premium puzzle" that has mystified experts. At the heart of the conundrum is why many investors favour bonds when the average return on equities over the long-term is considerably higher. What's more, when stock markets fall, investors shift from equities into bonds, even though that is wrong thing to do from a logical standpoint.

The study does not mean that you should hit yourself on the head with a mallet to be a better investor. However, it is important to learn to invest without emotion if you want to do well in the stock market. That is easier said than done because we tend to feel losses more acutely than gains of comparable magnitude.

One way around the problem is to buy a handful of good shares and hold them for as long as possible. This can help make risky assets more attractive. But you must never worry too much as to whether the shares are performing, or at least you must not evaluate their performance frequently. Follow the links below for more on unemotional investing!

> How To Be A Successful Investor | Ten Common Mental Mistakes Investors Make