The human limbic system controls our emotion, behavior and long-term memory (among other functions). “To the extent you succeed in finance, you succeed by suppressing the limbic system, your system 1, the very fast-moving emotional system. If you cannot suppress that, you are going to die poor.”
So says Dr. William J. Bernstein, Ph.D., M.D., retired neurologist, principal in the money management firm Efficient Frontier Advisors, and author of several best-selling books on finance. We last spoke with him in 2019. His new book The Delusions Of Crowds: Why People Go Mad in Groups gave us an excuse to delve more deeply into the human brain, and how its evolutionary development can lead us astray in modern capital markets.
The book focuses on three of our key characterizations: Humans are the Apes that tell stories, imitates others, and seek status. This combination ultimately leads to group dynamics where an entire population can become deeply entrenched in a belief system, that before it is revealed as false, runs amuck. The consequences range can include economic collapse, personal financial ruin, and 1000s of deaths.
Bernstein discusses the vectors and mediums of “infections” that lead to mass delusions. Humans are “cognitive misers,” relying on simple narratives versus more complex analytical thinking. The more compelling a narrative is, the more corrosive it becomes to our analytical abilities. The two most compelling causative agents: Apocalyptic “End of Days” and “effortless riches.” Hence, both money and religion narratives can create frequent and substantial crowd delusions.
From an evolutionary perspective, there is little cost to our “patternization” – seeing a pattern where none exists. Jumping out of the way at the sight of a stick that looks like a venomous snake – the “false positive” carries almost no cost. But “false negative” – ignoring something that looks like a snake and is a deadly viper – carries the ultimate evolutionary cost. This is in part why we attend to bad news, while ignoring good news. Investors should understand why the evolutionary traits that helped us survive on the savannah can counter-intuitively lead is to make expensive errors today.
A list of his favorite books are here; A transcript of our conversation is available here.
You can stream and download our full conversation, including the podcast extras on iTunes, Spotify, Stitcher, Google, Bloomberg, and Acast. All of our earlier podcasts on your favorite pod hosts can be found here.
Be sure to check out our Masters in Business next week with Jeff Immelt, former CEO of General Electric from 2001 to 2017. Immelt joined GE in 1982, in GE’s plastics, appliances, and healthcare businesses, and spent over 35 years with the company leading GE’s Medical Systems division from 1997 to 2000. His new book is: Hot Seat: What I Learned Leading a Great American Company.
