Jason Zweig, a senior writer for Money magazine, is the author of Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, published by Simon & Schuster. He recently spoke with Journal of Indexes assistant editor Heather Bell about his new book.
Journal of Indexes (JoI): Journal of Indexes (JoI): What does behavioral finance tell us about investing and indexing?
Jason Zweig (Zweig): About 10 years ago, I read an article in Scientific American. Most of the way through the article was this statement that people who have had their brains surgically snipped in half as a drastic treatment for epilepsy calculate probability completely differently. I decided I had to find out more about this.
From that point on I was just hooked. It was a long process because neuroscience, in general, and neuroeconomics in particular, are not very accessible fields for the layman. And I certainly was a layman when I started—and in many ways still am.
JoI: For this book, who do you see as your target audience? It seems like it has a lot for the retail investor and for the professional investor.
Zweig: I would hope so. I guess I would say it's really from the viewpoint of an individual investor, but already many professional investors have told me that they've gotten a lot out of it, both in terms of understanding general principles and also some ideas for organizational or procedural improvement in their analytical process or portfolio construction. The book is really about emotion, and even though all investors like to think of themselves as ''rational,'' I never yet have met a human being who was not at least partly emotional. For anyone who does experience emotion when you invest, it's important to understand how emotions are generated in the brain. That's really what the book is about, and how that interacts with your investing choices.
JoI: I saw the book as a very strong argument for index funds simply because that human element is largely removed from an index fund. Is this a valid conclusion to draw?
Zweig: Well, sure it is. I'm a huge believer in indexing, and I have been for longer than I can remember. Virtually 100 percent of my own portfolio is in index funds, and I actually do not own a single individual stock and haven't for quite some time. My ultimate conclusion is that there's an important distinction that needs to be drawn between what people should do and what they can do. What people should do is they should index their entire portfolio and then go on a 30-year hiatus, and at the end of the 30 years they would have a substantial amount of wealth built up. In the interim they would've been able to live their lives without all the upset of paying attention to the daily fluctuations of the market. That's what people should do, but it's not what they can do.
Very few people have the ability to buy a stock, vault it away in their portfolio and leave it until it makes them wealthy. I think there's a reason for that: The brain is not really very well-suited for that kind of behavior. Most people will buy more when something goes up and either sell it or freeze when it goes down. The brain is really built as a pattern-recognition machine and a performance-chasing mechanism, and when you combine automatically perceiving patterns where they don't actually exist with pursuing performance right before it disappears, you have a recipe for disaster.
Most people can't do what they should, so we need to advise them to do what they can. Increasingly, my advice for individuals and for financial advisors who serve them is that everybody should have two things: a lockbox and a sandbox. The lockbox has something like 90 percent of your money in index funds and nothing else. The sandbox, where you have maybe 5 percent or 10 percent of your money, is where, if you really want to, you can play a little. There's nothing terribly wrong with getting entertainment out of investing, as long as you understand that's what you're doing, and as long as you don't do it with all of your money.