Managing Your Portfolio By Managing Your Mind

You might be familiar with Homer’s epic tale of Ulysses and the Sirens. The mythical Sirens lived on rocky islands in the middle of the sea where they sang such beautiful melodies that passing sailors could not resist their call. Following the alluring melodies, these sailors would inevitably steer their boats toward them or even jump in the raging waters to get closer, always with the same result—disaster.

Ulysses possessed uncommon wisdom. He knew that his journey required that he pass the Sirens, but he wanted to hear the Sirens’ call. He knew that doing so would render him incapable of rational thought, so he put wax in his sailor’s ears so that they could not hear. Then they tied him to the mast so that he could not jump into the sea. He ordered them not to change course under any circumstances, and to keep their swords upon him to attack him if he broke free of his bonds.

Upon hearing the Sirens’ song, Ulysses was driven temporarily insane and struggled to break free so that he might join the Sirens, but fortunately his forethought and thorough planning worked, saving both his life and the lives of his men. Modern psychological research has revealed that Ulysses was onto something when it comes to managing the human psyche, which translates well to managing a retirement account as well.

In recent research by Dr Read Montague has uncovered ground-breaking insight on dopamine neurons. He gave subjects $100 each to invest in the stock market, supplying information on market trends and conditions from actual but not yet revealed historic market periods. Each subject participated in 24 rounds of investing, and would get to keep their earnings while Montague monitored the dopamine response in their brains.

What did Montague learn? When an investor placed a bet with 10 percent of his portfolio and saw his investments shoot up in value, the dopamine neuron pattern revealed a fixation—not on the winnings, but rather on the missed profits as his neurons calculated his possible returns relative to his actual returns.

So what would the subject do in the following investment round? He would wager more and more of his portfolio in search of the profits he previously missed in an effort to drown his regret with pleasurable dopamine. Interestingly, the longer the investment provided returns, the more the subject would grow in confidence that he had figured out the winning formula, forming a type of investment bubble that would end in utter surprise when the markets corrected and the bubble burst.

Another modern neuroscientist, David Eagleman, has provided some additional research into the brain and investing. In his recent book, Incognito: The Secret Lives of the Brain, Eagleman reveals that the conscious mind is not at the center of the brain’s action, but rather at the periphery. Our conscious decision making activity is often being directed by a staggering complex and competing neural sub-population.

One population looks at chocolate chip cookies and sees pleasure, another sees a high-energy source for survival, and yet another sees an hour on the treadmill at the gym. An unconscious democratic process unfolds inside our minds resulting in a split-second decision to eat or not eat the cookie. And while the cookie debate is fairly easily understood, the subconscious process becomes much more complex and subversive in areas such as finance. That is why Mr. Eagleman recommends that we make well-devised plans during moments of psychological clarity to help guide our minds in the important areas of life.

When it comes to portfolio management, many everyday investors do not have clear and strong investment principles to guide them. They are left subject to the Sirens of greed, fear, jealousy, and a host of other anxieties fomented by media, society, and Wall Street, which eventually lead to undisciplined and irrational investment decisions.

In contrast, professional portfolio managers work within strict asset allocation models that are rarely changed and only with strict review and committee decisions. Such institutional money managers know how to block out the Sirens and stay the course.

Ulysses was wise enough to foresee the temptations ahead and designed a plan to stay the course. Psychologists now call this mental discipline a Ulysses Pact. Do you have enough psychological clarity to know that down the road you too will want to abandon your investment ship in search of Siren songs of our day? Market swings, stock tips, bubbles, and stories of remarkable profits at cocktail parties will leave those bereft of a portfolio style Ulysses Pact tossed about by temptation, and apt to dive headlong into disaster.

The Sirens song will be strong. By forming a clear and rational portfolio allocation plan, and committing to stay the course over time through rigorous rebalancing, you can avoid the shoals and sail on toward retirement safety.