The lizard brain is verbal shorthand for the less cognitive, less abstract mental forces that influence our behavior. We have a prefrontal cortex that is rational—though often far from perfect—and we have the lizard brain, which is powerful, mysterious and ingenious. You think you can outsmart it, but you’re wrong.

For the lizard brain to help us, it has to spot signals that mean the same thing today that they did to our cave-dwelling ancestors. For thousands of years we could predict the outcome of the hunt by observing an animal’s footprints. When we look for cues in the patterns of financial markets, though, every single thing our brain was built to do is 100 percent wrong.

Of course we do not trust intuition when it comes to investing; for that we have advisors and research and performance data.

The lizard brain extrapolates from the past and applies it to the present. You think you have found a reliable relationship between two factors, so that when the Federal Reserve decreases the gold supply you go out and buy gold-mining companies. You think when a company’s share price is going up it will continue to go up.

I have had the opportunity to talk with some great investors—Paul Tudor Jones, for one. He had a handwritten sign over his desk that said “Observe that the blade of grass that resists the lawn mower gets cut down, while the blade that bends remains uncut.” I took that as his reminder to control the lizard brain. The right course requires us to swallow our pride, take a loss and move on. Those who appear to have a knack for timing the market actually have figured out that others are reacting with their lizard brains and they have to be one step ahead, going short when everyone else is long. In that sense, trading is a zero-sum game.

Precisely because people buy when markets are rising, they themselves push asset prices to the point that returns must stop rising and disappoint us.

You have confessed to having been an overly enthusiastic trader yourself.

I do not trade impulsively anymore. Of course, research is me-search; people go into areas that interest them. I had a lot of fun trading and I made a lot of money. I probably would have made more money if I had traded less actively.

How many neoclassical economists does it take to screw in a lightbulb?

The Answer—none, the invisible hand will do it—is based on the assumption that people are both selfish and smart, but financial markets are always efficient. Those who still believe Adam Smith was right about the invisible hand of the market should know that in his book that is less well-known today, The Theory of Moral Sentiments, published six years before The Wealth of Nations, he actually is much more aligned with the idea that people are not always either selfish or smart. The idea of people having any sort of willpower problem at all is completely foreign to the neoclassical school of economics.

That is why behavioral economists are gaining favor. Only 20 percent of all money managers actually beat the market, but most investors are irrational enough to think they can, so they behave accordingly.

Yes, Richard Thaler, the doyen of the behavioral school, says people are nicer and dumber than classical economics assumes. I do not consider myself a behavioral economist, though. I’m an economist who studies human behavior. A biologist would reconcile the subject of rational versus irrational behavior by observing that the way a person is programmed that can produce helpful behavior in one setting will produce bad behavior in another.

A quantitative analyst behaves very well in an environment of proprietary black-box models and statistical analysis of market trends, and is able to track down mispriced securities.

At least in principal you might think that if you could divorce yourself from day-to-day emotions you would do well in the market. Still, at the end of the day you have to interpret the numbers through either historical data or your brain. It is not obvious to me that you can escape the lizard brain by using quantitative analysis, but it is probably worth a try.

The only way to outperform the market is to take on more risk. Bonds—at least investment-grade ones—are for wimps.

I remember so clearly a day in the early 1980s when I was sitting in a crummy little apartment on the beach in San Diego, reading in a magazine that I should buy the current crop of U.S. dollar-denominated long bonds, which were a bet on Ronald Reagan. I thought, “This is idiotic advice. Land is going up, Postimpressionist paintings are selling at record highs; who would ever waste their money on these stupid bonds?” They produced tremendous gains year after year, with almost no down years. My lizard brain won that time; I did not buy them.

If in 1980 you had thrown darts at equities, bonds and real estate, you would have made money. So the lizard brain is telling us that to be rich in America, take risks, and when times are bad, hang on, risks will be rewarded. I do not mean to say we have a gloom-and-doom scenario ahead, but planning for a booming economy is not prudent.

Real estate continues to appreciate.

Real estate prices cannot grow faster than the national economy forever. Otherwise their percentage of total net worth would become 100 percent. The non-lizard brain says the market could plateau or decline.

Where the lizard brain steers us wrong is that it tells us to overextrapolate from the past, but people are unlikely to pay attention because they have been rewarded for buying property decade after decade. I say, do all the models of risk allocation, calculate what you think is the right amount of real estate to own, then cut it by a factor of four, or maybe 10.

Those who do not study the past are doomed to repeat it.

When it comes to assessing market performance, a rational look backward is really depressing. If we had been considering risk probabilities in 1950 or 1960, we would have had to factor in the chance of nuclear war with the Soviet Union. Now we know that up to this very moment the risk was zero, so when we look at the pattern of financial markets over the past 55 years we do not factor in the huge risk of a nuclear war. In assuming future performance will look like the past, we are drawing the wrong conclusions.
We are built to believe that we have more control over our actions than we do. I’m sure every CEO thinks he or she is more in charge than reality dictates.

Call it overconfidence, but my business is thriving because I have taken risks.

In the late 1980s I was a cofounder of a biotech company called Progenics Pharmaceuticals. In a meeting at Goldman Sachs, a partner there asked me, “What are the odds that this company will be successful? And don’t tell me 100 percent.” I said, “I know it can’t be 100 percent, but it feels like 100 percent to me.” In fact, the company was successful after a number of stresses and strains, and is now traded on Nasdaq. The point is, if you are an investor, do you want the head of a company to be the guy who says it has a 5 percent chance of success or the guy who says 100 percent and believes it? Of course you want the crazy person who will blow through the tough times. It requires that kind of confidence.

Overconfidence is actually something that serves us better than it did our ancestors. In ancient times you lived among the same group of people your entire life. So if you were Terry the overconfident boaster at age 20, people would remember that forever. In this world some people will remember forever your boasting that failed to pan out, but the opportunities for fresh starts are greater. Whatever the correct level of overoptimism was in a world where you could easily be killed if you thought you could go head-to-head in battle with an elephant, and all of your mistakes were remembered forever by every single person you knew, when you transfer that tendency to this world, your lizard brain might try to adjust your behavior in the wrong direction. It probably pays to be more optimistic than you feel.

If the lizard brain is a problem, someone must be working on a pharmaceutical solution.

To avoid problems, you have to change one of the two: the lizard brain or the modern world. Plenty of industries profit from lizard brain behavior, and are always happy to have you keep trading, use extended credit, respond to advertising cues. On the other hand, we are in the early stages of some attempts to save us from ourselves. Vaccines against nicotine cravings, for example, are a way of fighting the lizard brain.

Photograph by Thomas Hart Shelby