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A few words about your humble presenter
1.  Run an online quantitative research shop
2.  Manage or Advise $ Asset
3.  Area of interest Behavioral Economics/Neuro Finance
4.  Undergrad SUSB BA Pol Sci Emphasis on Math/Physics Phi
5.  Law Degree Benjamin Cardozo JD from YU
6.  Column for Washington Post & Bloomberg; TV, Radio
7.  Blog at The Big Picture (
and Tweet @Ritholtz
Everything we discuss today is backed by academic research
1.  What is Meta-Cognition?
2.  Your Brain is Lying to You – Almost All of the Time
3.  It’s a Feature, Not a Bug!
4.  You Are Not Wired to Make Intelligent Financial
5.  Why Very Smart People Truly Understand Ignorance
Today’s discussion . . .
This is Your Brain.
This is Your Brain on Drugs
1987 PSA
Your brain weighs 3 pounds, and is 100,000 years old. It is a “dynamic, opportunistic, self-organizing system
of systems.” MRIs have revealed to Neurologists what our brains looks like when making decisions . We can
observe it 1) in real time; 2) under actual conditions, and 3) in reaction to financial risk/reward stimuli.
Once we begin trading stocks, however, our brains begin to undergo subtle physical change that we can
actually see in the MRIs of Traders . . .
A brief intro to
Economics &
1. Optimism Bias
2. Experts: Articulate Incompetents
3. Herding, Groupthink
4. Confirmation Bias
5. Recency Effect
6. Emotions impact perception
7. Anticipation vs. Rewards
8. Selective Perception & Retention
9. A Species of Dopamine Addicts
10. Endowment Effect of Ownership
11. Monkeys Love a Narrative
12. Cognitive Errors Impact Processes
Behavioral Economics Neuro-Finance
How Does Your Brain Interfere With Your Investing?
If u cn rd ths
This animation . . .
. . . is not an animation
“Here, Tweetie”
Over Confidence
“Here, Tweetie”
What is Meta-Cognition?
Dunning Kruger Effect: is a cognitive bias in which unskilled people
make poor decisions and reach erroneous conclusions, but their
underlying incompetence at these tasks denies them the metacognitive
ability to recognize these mistakes.
Metacognition: The less competent you are at a task, the more likely
you are to over-estimate your ability to accomplish it well. Competence
in a given field actually weakens self-confidence.
The Math of Active Management is Daunting:
1. Only 20% of active managers (1 in 5) can outperform their
benchmarks in any given year;
2. Within that quintile, less than half (1 in 10) outperform in 2 out of the
next 3 years;
3. Only 3% stayed in the top 20% over 5 years (1 in 33)
4. Once we include costs and fees, less than 1% (1 in 100) manage to
outperform (net).
5. What are the odds you can pick that 1 in 100 manager?
Optimism Bias
Source: Morningstar, Vanguard
Source: Kal, Economist
Mutual of Omaha
“Lone Gazelle”
Sources:, NYT, McKinsey, Marketwatch
1.  Only 5% of Wall Street
Recommendations Are “SELLS”
-NYT, May 15, 2008
2. Why Analysts Keep Telling Investors
to Buy
-NYT, February 8, 2009
3. Equity Analysts Too Bullish and
Bearish at the Exact Wrong Times
-McKinsey, June 2nd, 2010
4. None of the S&P 1500 have a Wall St.
Consensus “Sell” on them
-Robert Powell, Editor, Retirement Weekly, August 2011
It is better for one's reputation to fail
conventionally than to succeed
-John Maynard Kyenes
Wall St. Groupthink: Buy Buy Buy!
Source: Zweig, Your Money & Your Brain; Grants Interest Rate Observer,
• Expert forecasters do no better than the average
member of the public;
• The more confident an expert sounds, the more likely
he is to be believed by TV viewers
• Experts who acknowledge that the future is inherently
unknowable are perceived as being uncertain – and
therefore less trustworthy. (Isaiah Berlin: Hedgehog vs
• The more self-confident an expert appears, the worse
their track record is likely to be.
• Forecasters who get a single big outlier correct are
more likely to underperform the rest of the time.
“Expert” Forecasting
Bennett Goodspeed, The Tao Jones (1984) discussed “The articulate incompetents:”
Ambiguous Uncertainty
“There’s no chance that the iPhone is going to get any significant market share.”
-Steve Ballmer, Microsoft CEO (April 2007)
“Cellular phones will absolutely not replace local wire systems.”
-Marty Cooper, inventor (1981)
“The Beatles have no future in show business. We don't like your boys' sound. Groups are out; four-piece
groups with guitars, particularly, are finished."
-Decca Records executive to Brian Epstein, in 1962
"There is no danger that Titanic will sink”
-Phillip Franklin, vice president of the White Star Line, which had produced the ship,
"The horse is here to stay but the automobile is only a novelty - a fad."
-President of Michigan Savings Bank, advising Henry Ford's lawyer, Horace Rackham, not to
invest in Ford Motor Co., 1903
"If excessive smoking actually plays a role in the production of lung cancer, it seems to be a minor one."
-W.C. Heuper, National Cancer Institute, 1954.
“There is no reason anyone would want a computer in their home.”
-Ken Olson, president Digital Equipment Corp (1977)
“Expert” Forecasts
1. We tend to read that which we
agree with; We avoid that which
disagrees with our preconceived
biases, notions or ideologies;
2. Our biases change the way we
perceive objects – literally, the way
we see the world.
3. The same biases affect our
memories – we retain less of what
we disagree with . . .
4. Expectations Affect Perception
Selective Perception & Retention
Confirmation Bias
Source:, WSJ
WSJ: 2007 WSJ: 2010
Beware the Recency Effect
Source:, Fortune, Time
Time, June 2005
Fortune, June 2005
What Just Happened vs. What is Going to Happen
Fed Ex Logo Redesign
FedEx logo is legendary among designers. It has won over 40 design awards and was ranked as
one of the eight best logos by Rolling Stone
When it absolutely positively
has to deceive your eyes overnight
FedEx logo is legendary among designers. It has won over 40 design awards and was ranked as
one of the eight best logos by Rolling Stone
What does this mean for investors?
• We have an Optimism bias (helps our survival).
• Our brains are better at processing good news about the future than bad.
• Anticipation of financial reward > than actual benefits (Buy Rumor, Sell News)
• Gamblers, Alcoholics, Sex Addicts, Junkies, OA, Hyper-Traders = Dopamine High.
A Species of Dopamine Addicts
We prefer stories to data –
Pre-writing, story-telling is how
Humans evolved to share information
We are vulnerable to anecdotes that
mislead or present false conclusions
unsupported by data
Monkeys Love a Narrative
Sentiment Cycle
"The purpose of studying economics is not to
acquire a set of ready-made answers to economic
questions, but to learn how to avoid being deceived
by economists."
-Joan Robinson, Cambridge
“All models are wrong, but some are useful.”
-George Box
Why Study Economics?
“The fool doth think he is wise, but the wise man, knows
himself to be a fool.” -William Shakespeare, As You Like It
“Knowing yourself is the beginning of all wisdom.”
“Faced with the choice between changing one’s mind and
proving that there is no need to do so, almost everyone gets
busy on the proof.” - John Kenneth Galbraith
"One of the greatest pieces of economic wisdom is to know
what you do not know." -John Kenneth Galbraith
"If you torture the data long enough, it will confess to
anything." -Ronald Coase
"It ain’t what you don’t know that gets you into trouble. It’s
what you know for sure that just ain’t so." -Mark Twain
Barry L. Ritholtz
CEO, Director of Equity Research
for more information, please contact
My favorite books on these subjects can be found at