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The Irrational Lizard Brain

Terry Burnham, Ph.D., director of portfolio management and director of economics at Acadian Asset Management, answered our 10 Questions.

Terry Burnham, 06/22/2010

Burnham will speak at the 2010 Morningstar Investment Conference.

You wrote a book called Mean Markets and Lizard Brains (Wiley, 2008). What is the lizard brain?
The lizard brain is the part of you that wants to eat junk food, sleep in late, and watch TV. More formally, I define the lizard brain as all the brain except for the prefrontal cortex, the center of rational decision-making.

What is the most costly behavioral mistake investors make?
Investors tend to buy assets after they have gone up when they ought to buy assets that will go up.

How should they avoid making this mistake?
Lock up the lizard brain. In practice, this means setting up processes that don't allow emotional decisions. Slow and methodical is the correct way to make financial decisions.

If we are built to be bad investors, shouldn't we simply buy and hold cheap index funds and be done with it?
The key is emotionless, disciplined investing. For some investors, index funds can play a role, but there are other investing styles that can work well.

What techniques do you personally use to overcome your lizard brain?
When I get a brownie with my airline meal, I cover the brownie with mayonnaise. Thus, I am no longer tempted to eat it. In financial decisions, the lesson is the same. Put your money where you cannot make decisions in the short term.

What investor bias do you suffer from the most?
I get excited by big price moves. I want to buy assets that have gone up a lot and sell assets that have been dumped. The difference between successful and unsuccessful is not in our emotional response to price moves, but in our behavior. Almost everyone wanted to sell stocks in the spring of 2009, but not everyone made that mistake.

Acadian uses quantitative models to attempt to capitalize on investors' behavioral errors. How does this process work?
First, we are structurally set up to follow a disciplined process and not make most behavioral mistakes. Second, we study investors' mistakes and build portfolios that we think are on the other side of these mistakes.

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