How to ‘light up’ your brain like Warren Buffett

Published: July 17, 2014 5:00 a.m. ET




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So, what’s on your nucleus accumbens?

Does Warren Buffett think differently from you and me? The science says yes, he does.

Researchers from Caltech and Virginia Tech set up a virtual trading game to study how ordinary people make choices in a volatile market. Then they took scans of the participants' brains as they tried to make money.

The scientists (they call themselves "neuroeconomists") looked closely at oxygen flow to regions of the brain, watching them "light up" as activity levels surged. As it turns out, in a bull market most people's brains fire in the nucleus accumbens, an area of the brain that processes the idea of reward. They buy and buy more, right past the price peak.

Fascinatingly, researchers found that pricing bubbles happened without external prompting, such as media hype. Watching cable TV pundits doesn't help, yet most of us are perfectly capable of losing money all on our own.

A small number of investors, meanwhile, receive contrary signals from the insular cortex. This is the part of your brain that fires when you smell something rotten or there is the risk of being shocked, even of being socially excluded or otherwise made uncomfortable.

Guess who makes more money? Yep, the cautious person who sells even as asset prices are rising, essentially Buffett's dictum of being fearful when others are greedy and greedy when they are fearful. The paper's findings appear this week in the Proceedings of the National Academy of Sciences.

Bull market

As stocks bust through record highs daily (and if it rises only a tiny bit, yes, a record is set) the pundits ask, inevitably, if the bull market can continue. The researchers' findings suggest that it can.

That's because as stocks go higher most of us are wired to keep buying, like the subjects in the experiment. Our minds react to higher prices not by feeling the urge to sell and protect gains. Rather, we get the overwhelming urge to buy even more.

How can you become more like Buffett? Well, it would be nice to have his capital, know-how and leverage capabilities, not to mention his personal network. But retirement investors don't and never will.

Yet they can remove their miswired brains from the investing process. That's the beauty of rebalancing among a basket of investment classes. By owning slices of the market cheaply through index exchange-traded funds, you set yourself up for exposure to a variety of different markets.

Inevitably, their relative valuations will diverge. Conscientious rebalancing — selling off assets that rise in value and then using the cash to buy assets that have fallen in comparison — is an end-run on your own gray matter. It's retirement investing like Buffett, automated.

Simple and painless

Sure, your nucleus accumbens is screaming "buy more" while your insular cortex is taking a huge nap. But you can override all that and just rebalance anyway.

The first time is hard. Then it becomes as simple and painless as brushing your teeth. Over the last 15 years, just the act of rebalancing gave investors a 1.5% edge over the straight stock market, according to research done by Princeton's Burton Malkiel, a member of the Investment Committee of my own firm, Rebalance IRA.

Like with any good science, observation leads to a hypothesis and then testing. Burt and his colleagues "knew" what the Caltech researchers have found with hard science, much as Buffett always knew it because he is in the minority who trade differently, thanks to their brains.

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