Do you jump when you hear a good investment story, or do you wait and research the pertinent facts before committing your capital? How you invest makes a big difference in your wealth.
Right brain investors respond quickly to investment ideas soon after envisioning an increase in wealth, even if the numbers don't add up. They focus is on the possibility of winning rather than the probability of losing.
Right brain investors are perfect candidates for stockbrokers and money manager who specialize in selling the dream of beating the market, even though the odds of doing so are poor. It's how most investment products are sold on Wall Street and by advisors who claim they can "beat the market." [More from Forbes: 9 reasons why Joe Six-Pack can't invest like Warren Buffett]
Right brain investing requires little knowledge and no heavy thinking, which is why most people invest poorly. They hear a story from a financial person, or read about an ETF on Yahoo news, and then they invest thousands of dollars without doing any research. Ironically, these same people will agonize for weeks over which cell phone to buy.
Impulse investing is akin to glancing at a billboard advertising a $100 million lottery and screeching off the highway to find the next convenience store that sells tickets. The large jackpot creates an emotional impulse where we envision wealth, glory, and a worry-free lifestyle. The reason there's not a lot of accidents around intersections where those billboards exist is because the left brain kicks in and reminds us how incredibly low the odds are of winning. This stops most people from making the "investment." [What makes emerging markets great investments]
Nobel laureate Daniel Kahneman describes right brain investing as System 1 decisions in his recent book, Thinking, Fast and Slow. System 1 thoughts are reactionary. There isn't any deep thinking going on. If an investment sounds good, it must be good. Relying on intuition for investment decisions is a mistake. As Kahneman states, "We are prone to overestimate how much we understand about the world and underestimate the role of chance in events."
I worked for two major Wall Street firms during the late 1980s and 1990s and can attest to the flaw in System 1 investing. Early in my career, I believed that stockbrokers relied on sound research and insightful analysis from their firms. Boy, was I wrong! That was definitely a System 1 mistake.
I quickly learned that Wall Street isn't about sound judgment and making prudent decisions for clients — it's about selling to people who make impulsive right brain decisions. During broker boot camp, I was instructed to forget that facts — sell the sizzle, not the steak. Our text book was The Art of Selling Intangibles by Leroy Gross, a successful stockbroker in his day. Gross wrote that the key to successful selling is greed, and that we should use this to our advantage:
Nothing captures interest faster or keeps it at a higher level than the mouth-watering thought of a profit. If the potential is large, your prospects interest focuses sharply on your next comments.
This is pure System 1 right brain selling. If technology stocks are hot, sell technology funds. If real estate is hot, sell REIT funds. In a down market, when emotional clients call, sell their stock funds and buy bond funds. One broker could be selling a U.S. stock fund because it's "bad," and the broker in the next office could be buying the same fund because it is "great!" Who cares whether this is prudent or not? We earned a commission on each trade. This is why I'm not in that business anymore! [More from Forbes: 12 warnings signs an investment is a scam]
Another problem with a right brain selling is that Goldilocks stories tended to become Greek tragedies. Investors pay a big price for the illusion of management. Decisions made based on the belief that superior returns will be earned, or that money will be sheltered in a down market, often result in lower returns than sticking with one strategy. Bad behavior takes a toll on investor returns. See this recently updated DALBAR QIAB study for more information.
Many investment advisors and financial planners are no better than brokers. They pitch their skill at beating the market by saying they have the ability to choose the right mutual funds at the right time. I am sure that a handful of these advisors do have luck or skill, but most don't. History shows us that the real winners are few and far between, and it's not possible to know who the winners will be in advance.
Kahneman explains in his book that the successful fund managers are almost 100 percent lucky, and that the winners each year are based almost entirely on a roll of the dice. The same is true for advisors who claim skill in selecting winning investments. The winners this year will be the losers next year. It's an expensive magic show held exclusively for right brain investors.
Our right brain is incapable of considering risk and return simultaneously. That's the job of our left brain. The left brain provides the analytical thought that the right brain lacks. Kahneman calls this System 2, or slow thinking. It's System 2 that is in charge of recognizing and changing the biases inherent in System 1 decisions. [More from Forbes: The 20 best-paying jobs for people persons]
When we see a $100 million lottery, our right brain says "Wow! Let's get some." while our left says "Wait a minute. Let's think about this." The odds for winning a $100 million jackpot are about 300 million to 1. The left brain reminds us of these odds, and stops us from spending our retirement money trying to win the lottery (at least for most people).
Left brain investors examine all the facts that are available before making a reasonable choice between risk and return. They look at the past figures and future probabilities. They'll consider overall portfolio construction, fund expenses, turnover, taxes, etc. This analytical work uncovers many issues with investments that right brain people miss.
Left brain investors understand that the probability of loss is more important than the possibility of return. This knowledge makes them ideal candidates for low-cost index funds and ETFs that track market returns. Although the allure of beating the market is enticing to everyone, left brain investors have learned that the probability of an active fund portfolio outperforming an index fund portfolio is close to zero over the long-term.
Don't be a right brain investor. Ignore the temptation to believe stockbrokers and investment advisors who claim to have a magic formula. Don't buy past winning funds, or funds with trendy themes, or a fund that some staff writer recommended in Beautiful Investment Magazine just before the colorful, two-page ad placed by the same fund company.
Left brain investors buy index funds and ETFs in a well-structured portfolio because this strategy has the highest probability for long-term success. Then they stay the course through thick and thin because that has proven to work. Left brain investors know that thinking slow gets you to your financial goals faster than thinking fast!