examples ofmarket-beating portfolios on his web site,17 and both men are on the advi-sory board of Dimensional. Dimensional follows three principles in stockselection. They allocate more assets to equities over ﬁxed income (takingadvantage of the equity risk premium. They invest more in small companystocks due to their higher long-term returns. And they allocate more re-sources to lower-priced value stocks, which have higher expected returnsthan higher-priced growth stocks.18
Other notable behavioral ﬁnance-oriented fund groups with signiﬁcanttrack records include funds managed by David Dremen and LSV Asset Man-agement (LSV was founded by some of the pioneers in behavioral ﬁnance).In the past few years, many large banks and fund management organiza-tions have been jumping on the behavioral ﬁnance bandwagon, includingMorgan Stanley and J. P. Morgan.
BEHAVIORAL INVESTMENT PRODUCTS
Individual investors can beneﬁt from investment programs that accommo-date their emotional biases. Currently, few Americans save enough for re-tirement, often due to a combination of several biases: time discounting(procrastinating the pain of saving), inertia (indecision and doing nothing),fear of market risk (avoiding investing in the equity markets), and overcon-ﬁdence (believing one can save more later).
Professors Shlomo Benartzi and Richard Thaler designed a retirementprogram to improve savings rates, which they called the SMarT plan. “Ourgoal was to design a program to help those employees who would like tosave more, but lack the willpower to act on this desire.” The program hasbeen a tremendous success in increasing retirement savings rates, withthe average saving rates for SMarT program participants increasing from3.5 percent to 13.6 percent over the course of 40 months.19
The SMarT plan is implemented as follows. First, employees are ap-proached about increasing their contribution rates approximately threemonths before their scheduled pay increase. Second, once they join, theircontribution to the plan is increased beginning with the ﬁrst paycheck after
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a raise. Third, their contribution rate continues to increase on each sched-uled raise until the contribution rate reaches a preset maximum. Fourth,the employee can opt out of the plan at any time.
In order to encourage employees to sign up for the SMarT plan, the re-searchers postponed the pain of the savings until later. Additionally, theyallocated a higher percentage of employees’ future raises to go towardtheir savings, so short-term pain was minimized. Furthermore, the design-ers take advantage of automaticity, which ensures that individuals do notneed to take action in order to save. U.S. government legislation passedin 2006 requires the implementation of “opt-out” retirement programs. Inopt-out programs, employees are automatically placed into a retirementsavings scheme, with a percentage of income regularly deducted towardretirement savings. They will remain enrolled every year unless they takeaction to be removed. Every year they are automatically reenrolled. Suchautomaticity challenges individual inertia.
Besides the SMarT plan, there are numerous other attempts to includebehavioral ﬁnance principles in the design of ﬁnancial products. “Goal-based investing” harnesses the psychological bias of mental accounting byplacing one’s savings in multiple targeted portfolios. The goal of this ap-proach is to simplify the investing process and render it more understand-able.
“Life cycle” asset allocation strategies increase the distribution of in-vestments to ﬁxed-income (bonds) from riskier equities as one ages. Thisis an automatic change based on one’s age at enrollment, and it accommo-dates the natural increase in risk aversion beyond retirement.
FINAL NOTES
This book has covered a lot of ground, not all of it elegantly or concisely.While the ﬁeld of behavioral ﬁnance is now getting its “legs,” neuroﬁnanceis still in its infancy. However, the tools offered by neuroﬁnance, such asneurofeedback, brain-oriented coaching and training paradigms, and ﬁnan-cial personality typing, are coming along quickly. The main factor impedingprogress is the lack of trained talent to both perform research and apply itto investing. Another impediment is the lack of portable, comfortable, andconvenient neuroscience technologies.
Is “neuroﬁnance” shaping up to be another fad—here today, gone to-morrow? I don’t think so. Neuroﬁnance has not yet been signiﬁcantlyexploited by investors, both on a personal level and in the design ofportfolios and trading strategies. Neuroﬁnance has a fundamental power,based on the inner processing of millions of interacting brains, and rooted
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in psychological laws. As the decades pass, technology becomes moredeveloped, and acceptance increases, neuroﬁnance will make large-scalecontributions to the investing process. However, neuroﬁnance is currentlyin its infancy.
It is my hope that individual investors can apply some of the insightsand knowledge in this book to their daily investing. While emotions, mo-tivations, cognitive biases, and emotional defenses are all subconscious,learning about them brings them closer to the surface. With awareness anddiscipline, action can be taken to correct one’s vulnerabilities and enhanceone’s strengths. People have been struggling with unconscious biases formillennia. Training regimens, such as those provided by meditation andyoga, have been developed and honed over generations.
Suggestions for self-help are distributed throughout this book, but onecaveat is that without an external coach or guide, the use of these tech-niques can be easily disregarded (another emotional defense!).
If you choose to embark on a journey of inner work, remember thatthe outer rewards (proﬁts) are only a side beneﬁt. A happy and rewardinglife is the ultimate achievement.
Thank you for taking the time to read this book. Please feel free to com-municate questions and comments to the author. May you be prosperousand well.
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Introduction
1. Lewis, M. 1990. Liar’s Poker New York: Penguin, p. 15.2. Loewenstein, R. 2000. When Genius Failed: The Rise and Fall of Long
Term Capital Management. New York: Random House.
3. MacKay, C. 1841. Extraordinary Popular Delusions & the Mad-ness of Crowds. Crown Publishing: London. www.historyhouse.com/book.asp?isbn=051788433X.
4. Powers, R. 2005. Mark Twain: A Life. New York: Free Press, p. xi.5. Twain, Mark. 1872. Roughing It, Chapter 26. Free Public DomainBooks from the Classic Literature Library. http://mark-twain.classic-literature.co.uk/roughing-it/.
6. Ibid.7. Ibid., Chapter 58.8. Ibid.9. Statman, M. 2003. “A Century of Investors.” Financial Analysts Journal
59(3) (May/June).
Chapter 1: Markets on the Mind
1. Johnson, R. L. 1998. “Day Trading: An Analysis of Public Day Tradingat a Retail Day Trading Firm.” www.nasaa.org/searchable ﬁles/1405/Day Trading Analysis.pdf.
2. Frew, A. 1999. “States Spearhead the Crackdown on Day Trading, but IsIt Warranted?” Money.CNN.com. September 1. http://money.cnn.com/1999/09/01/investing/daytrade regulators/.
3. Karmin, C., and M. Sesit. 2005. “Currency Markets Draw Speculation,Fraud Day Traders Find New Outlet in Foreign-Exchange Wagers; ‘ALot of George Soros Wannabes.’” Wall Street Journal, July 26.
4. Barber, B. M., Yi-Tsung Lee, Yu-Jane Liu, and Terrance Odean. 2005.“Who Loses from Trade? Evidence from Taiwan.” AFA 2006 BostonMeetings Paper. http://ssrn.com/abstract=529062.
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5. Odean, T., and B. Barber. 2000. “Trading Is Hazardous to Your Wealth:The Common Stock Investment Performance of Individual Investors.”Journal of Finance 55(2): 773–806.
6. Odean, T. 1998. “Are Investors Reluctant to Realize Their Losses?”
Journal of Finance 53: 1775–1798.
7. Odean, T., and B. Barber. 2000. “You Are What You Trade,” Bloomberg
Personal Finance, May.
8. Odean, T. 1999. “Do Investors Trade Too Much?” American Economic
Review, December: 1279–1298.
9. Bogle, J. C. 2005. “The Mutual Fund Industry Sixty Years Later: For Bet-ter or Worse?” Financial Analysts Journal 61(1) (January/February):15–24.
10. Dalbar Press Release. 2003. DALBAR’s 2003 update to the Quan-titative Analysis of Investor Behavior (QAIB) www.dalbarinc.com/content/printerfriendly.asp?page=2003071601.
11. Wermers, R. 2000. “Mutual Fund Performance: An Empirical Decom-position into Stock-Picking Talent, Style, Transactions Costs, and Ex-penses.” Journal of Finance 55(4) (August).
12. Carhart, M. 1997. “On Persistence in Mutual Fund Performance.” Jour-
nal of Finance 52: 57–82.
13. Wermer, et al., 2006. “Can Mutual Fund Stars Really Pick Stocks? New
Evidence from a Bootstrap Analysis.” SSRN working paper.
14. Mizrach, B., and S. Weerts. 2004. “Experts Online: An Analysis of Trad-ing Activity in a Public Internet Chat Room.” Departmental WorkingPapers 200412, Rutgers University, Department of Economics.
15. Georgette, J. 2002. “Putting Away the Darts after 14 Years: The WallStreet Journal’s Dartboard Ends Its Run.” Wall Street Journal, April18.
16. Michaely, R., and K. Womack. 2005. “Market Efﬁciency and Biases.” InRichard Thaler (ed.), Advances in Behavioral Finance, vol. II. NewYork: Russell Sage Foundation.
17. Barber, B., and D. Loefﬂer. 1993. “The ‘Dartboard’ Column: Second-Hand Information and Price Pressure.” Journal of Financial andQuantitative Analysis 28: 273–284.
18. Barber, B., R. Lehavy, M. Nichols, and B. Trueman. 2001. “Can In-vestors Proﬁt from the Prophets? Security Analyst Recommendationsand Stock Returns.” Journal of Finance, 61, no. 2: 531–563.
19. Fuller, R. 1998. “Behavioral Finance and the Sources of Alpha.” Journal
of Pension Plan Investing 2(3) (Winter).
20. Ibid.21. An average alpha computed from “returns since inception” versusthe benchmarks. Taken from 2Q 2006 report. www.fullerthaler.com/QuarterlyReview/newsltr2006Q2.pdf.
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22. Mauboussin, M. 2006. More Than You Know. New York: Columbia Uni-
versity Press.
23. Ibid., p. 83.24. Hirshleifer, D., and T. Shumway. 2003. “Good Day Sunshine: StockReturns and the Weather.” Journal of Finance 58(3) (June): 1009–1032.
25. Kamstra, M., L. Kramer, and M. Levi. 2003. “Winter Blues: A SADStock Market Cycle.” American Economic Review 93(1) (March): 324–343.
26. Limpaphayom, P., P. Locke, and P. Sarajoti. 2005. “Gone with the Wind:Chicago Weather and Futures Trading.” 2005 FMA Annual Meeting con-ference paper. www.fma.org/Chicago/Papers/gloom doom weatherfutures trading.pdf.
27. Krivelyova, A., and C. Robotti. 2003. “Playing the Field: GeomagneticStorms and the Stock Market.” Working paper, Federal Reserve Bankof Atlanta.
28. Yuan, K. Z., L. Zheng, and Q. Zhu. 2001. “Are Investors Moonstruck?Lunar Phases and Stock Returns.” September 5. http://ssrn.com/abstract=283156 or http://dx.doi.org/10.2139/ssrn.283156“ \t ” blank.29. Clarke, R., and M. Statman. 1998. “Bullish or Bearish?” Financial Ana-
lysts Journal, May/June.
30. Fisher, K., and M. Statman. 2000. “Investor Sentiment and Stock Re-
turns.” Financial Analysts Journal, March/April.
31. Ibid.32. Ibid.33. Fisher, K., and M. Statman. 2004. “Sentiment, Value, and Market-
Timing.” Journal of Investing, Fall: 10–21.
Chapter 2: Brain Basics
1. Goleman, D. 1995. Emotional Intelligence: Why It Can Matter More
than IQ. New York: Bantam.
2. Damasio, A. 1999. The Feeling of What Happens: Body and Emo-tion in the Making of Consciouness. New York, Harcourt Brace &Company.
3. Beer, J. S., R. T. Knight, and M. D’Esposito. 2006. “Controlling the Inte-gration of Emotion and Cognition: The role of Frontal Cortex in Distin-guishing Helpful from Hurtful Emotional Information.” PsychologicalScience 17 (May): 448–453.
4. Bechara, A., A. R. Damasio, H. Damasio, and S. W. Anderson. 1994. “In-sensitivity to Future Consequences Following Damage to Human Pre-frontal Cortex.” Cognition 50: 7–15.
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5. Bechara, A., H. Damasio, D. Tranel, and A. R. Damasio. 2005. “The IowaGambling Task and the Somatic Marker Hypothesis: Some Questionsand Answers.” Trends in Cognitive Sciences 9(4) (April).
6. Bechara, A., H. Damasio, D. Tranel, and A. R. Damasio. 1997. “DecidingAdvantageously before Knowing the Advantageous Strategy.” Science275: 1293–1295.
7. MacLean, P. D. 1990. The Triune Brain in Evolution: Role in Paleo-
cerebral Functions. New York: Plenum Press.
8. Prabhakaran, V., B. Rypma, and J. D. Gabrieli. 2001. “Neural Substratesof Mathematical Reasoning: A Functional Magnetic Resonance Imag-ing Study of Neocortical Activation during Performance of the Nec-essary Arithmetic Operations Test.” Neuropsychology 15(1) (January):115–127.
9. Davidson, R. J., D. C. Jackson, and N. H. Kalin NH. 2000. “Emotion,Plasticity, Context, and Regulation: Perspectives from Affective Neu-roscience.” Psychological Bulletin 126: 890.
10. Spencer, H. 1880. Principles of Psychology. New York: Appleton
Press.
11. Heath, R. G. 1964. “Pleasure Response of Human Subjects to DirectStimulation of the Brain: Physiologic and Psychodynamic Considera-tions.” In R. G. Heath (ed.), The Role of Pleasure in Human Behavior.New York: Hoeber, pp. 219–243.
12. O’Doherty, J., R. Deichmann, H. D. Critchley, and R. J. Dolan. 2003.“Temporal Difference Models and Reward-Related Learning in the Hu-man Brain.” Neuron 38: 329–337.
13. Karama, S., A. R. Lecours, J. M. Leroux, et al. 2002. “Areas of Brain Ac-tivation in Males and Females during Viewing of Erotic Film Excerpts.”Human Brain Mapping 16(1): 1–13.
14. Rilling, J., D. Gutman, T. Zeh, et al. 2002. “A Neural Basis for Social
Cooperation.” Neuron 35(2): 395.
15. Erk, S., M. Spitzer, A. P. Wunderlich, et al. 2002. “Cultural Objects Mod-
ulate Reward Circuitry.” Neuroreport 13(18): 499–503.
16. Mobbs, D., M. D. Greicius, E. Abdel-Azim, et al. 2003. “HumorModulates the Mesolimbic Reward Centers.” Neuron 40(5): 1041–1048.
17. de Quervain, D. J., U. Fischbacher, V. Treyer, et al. 1994. “The Neural
Basis of Altruistic Punishment.” Science 305(5688): 1254.
18. “Lessons from the Brain-Damaged Investor.” Wall Street Journal, July
21, 2005.
19. Chang, H. K. 2005. “Emotions Can Negatively Impact InvestmentDecisions” (September). Stanford GSB. www.gsb.stanford.edu/news/research/ﬁnance shiv invesmtdecisions.shtml.
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Chapter 3: Origins of Mind
1. Schultz, W., P. Dayan, P., and P. R. Montague. 1997. “A Neural Substrate
of Prediction and Reward.” Science 275: 1593–1599.
2. Suri, R. E., and W. Schultz. 2001. “Temporal Difference Model Repro-duces Anticipatory Neural Activity.” Neural Computation 13: 841–862.
3. See note 1.4. Medvec, V. H., S. F. Madey, and T. Gilovich. 1995. “When Less IsMore: Counterfactual Thinking and Satisfaction among Olympic Medal-ists.” Journal of Personality and Social Psychology 69(4) (October):603–610.
5. Kirsch, I., and G. Sapirstein. 1998. “Listening to Prozac but HearingPlacebo: A Meta-Analysis of Antidepressant Medication.” Prevention& Treatment 1 (June).
6. Talbot, M. 2000. “The Placebo Prescription.” New York Times, January
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8. Ibid.9. Kunda, Z. 1990. “The Case for Motivated Reasoning.” Psychological
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10. Ditto, P. H., G. D. Munro, A. M. Apanovitch, et al. 2003. “SpontaneousSkepticism: The Interplay of Motivation and Expectation in Responsesto Favorable and Unfavorable Medical Diagnoses.” Personality and So-cial Psychology Bulletin 29(9): 1120–1132.
11. Westen, D., P. Blagov, K. Harenski, C. Kilts, and S. Hamann. 2006. “AnfMRI Study of Motivated Reasoning: Partisan Political Reasoning inthe U.S. Presidential Election.” Working paper. October 1. http://www.uky.edu/AS/PoliSci/Pefﬂey/pdf/Westen%20The%20neural%20basis%20of%20motivated%20reasoning.pdf.
12. Ibid.13. Ibid.14. Dawson, E., T. Gilovich, and D. Regan. 2002. “Motivated Reasoning andPerformance on the Wason Selection Task.” Personality Social Psy-chology Bulletin 28: 1379–1387.
Chapter 4: Neurochemistry
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2. Aghajanian, G., and E. Sanders-Bush. 2006. “Serotonin.” Neuropsycho-pharmacology: The Fifth Generation Process. www.acnp.org/Docs/G5/CH2 15–34.pdf.
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8. Rogers, R. D., M. Lancaster, J. Wakeley, and Z. Bhagwagar. 2004.“Effects of Beta-Adrenoceptor Blockade on Components of Hu-man Decision-Making.” Psychopharmacology (Berlin), 172(2) (March):157–164.
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11. Gesch, C. B., S. M. Hammond, S. E. Hampson, et al. 2002. “Inﬂuenceof Supplementary Vitamins, Minerals and Essential Fatty Acids on theAntisocial Behaviour of Young Adult Prisoners: Randomised, Placebo-Controlled Trial.” British Journal of Psychiatry, 181 (July): 22–28.
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22. Nesse, R. 2000. “Is the Market on Prozac?” The Third Culture, February
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