Want to become a better investor? Get brain damage. That's the finding of a rather unusual study by researchers from Carnegie Mellon University, the Stanford Graduate School of Business and the University of Iowa. It was published in Psychological Science in June, and its conclusions were reported in The Wall Street Journal last week. But don't start playing football without a helmet just yet: It's not any type of brain damage that helped investors in the study, but rather, a very specific form: a site-specific lesion (a kind of tissue damage) in the region of the brain in charge of controlling emotions. The investors who have these lesions are unable to experience fear or anxiety. It turns out that lacking the emotionality ordinary investors exhibit leads to better investment decisions. It is not at all surprising that the emotionally limited investors outperformed their peers. We know from experience that when investors allow their emotions to unduly influence them, they tend to make foolish -- and expensive -- decisions. It was not simply a lack of emotions that caused the improvement in performance in the study. When presented with a high risk, higher return possibility, the participants with these site-specific lesions lacked the fear the other investors had. The more emotional participants failed to capitalize on these opportunities. In other words, they were greedy at the right time. That accounted for nearly all the difference in their performances. But the basic lesson from the study is simple: Investors who learn how their emotions impact their investing -- and can get them under control -- stand to significantly improve their returns.
Emotions Undercut Performance
As discussed previously , human beings just weren't built for capital markets. We have numerous design flaws that work against us in the investment process. But once you become aware of how they impact your thinking, you have a chance at avoiding some of the more damaging behaviors. At the very least, you can try to work around some of these hard-wired foibles. There are three broad categories in which emotions work against the investor: ego, flawed analyses and the derailed plan. Let's look at some examples within each category.