Monday, August 10. 2009
David Krueger MD
- And how was he able to con so
many smart people?
- We make money mistakes and
financial fallacies because of the ways that our minds and our
brains work. The Madoff tragedy illuminates some of the more
prominent errors.
- Exclusivity.
The desire to be special, even “chosen” vaults someone beyond
common sense to an emotional choice. Madoff appealed to his
target’s desire for status by including them in an exclusive club,
even turning down potential investors. One investor said, “You
had to go to him—he didn’t come to you. The first two or three
times he said, ‘Not yet.’ Until finally when he said ‘Yes’
you gave him every penny.”
- Transference fallacy.
Madoff was believable as an authority figure, especially confirmed
by the fact that he was Chairman of the NASDAQ, a philanthropist,
and had a huge following of admirers. We tend to idealize figures
who portray confidence and manifest wealth in the hope of
participating in some of their glory.
- Social contagion.
People are persuaded to join group momentum in order to
participate, especially not to be left out. By reacting to trends,
herd mentality creates trends.
- Confirmation bias.
Once you make a choice, the tendency to reinforce the belief that
this is the best choice—to cherry pick data to confirm that you’ve
made the right decision—obscures evidence to the contrary. People
continued to invest, and invited their friends to invest with
Madoff.
- Proving your worth.
Often the victims of a scam want to prove their worth. Madoff’s
scam could have been his self-statement: insiders said he wished he
had gone to Wharton or Stanford, but instead went to Hofstra
University, so always felt he needed to prove something.
- Specialness. Someone
who offers an evocative promise that crystallizes vague, hazy dreams
to make them seem vividly in reach can generate a cult-like
following. The (scam) artist paints a picture to allow people to
see what they want to see; then the victims project their own
desires onto a promising story that crystallizes a fantasy of
magical wealth. The scam artist is half of the co-created scam.
- Greed.
Emotion and immediacy will trump logic and thinking. The
excitement of an opportunity places neurocircuitry in collaboration
with a promise—a good story. When someone makes money, the region
of the brain called the nucleus accumbens lights up. This is the
same pleasure center that responds to other highs, even cocaine.
The drive to obtain a reward can resemble the addictive response of
cocaine: Both are processed by the pleasure center. When financial
incentives present a strong allure, reason as well as motivation can
be hijacked by the pleasure center.
- What can we learn from the
Madoff debacle?
- Don’t make significant
financial decisions when you’re vulnerable. Greater vulnerability
occurs at times of crisis such as divorce, job loss, death in the
family, or economic downturn.
- Be wary of hearing what you want
to hear. Once you make a decision, continue to objectively exam the
decision and look for evidence that it is right, and that it is
possibly the wrong decision. Notice when you cherry pick data to
confirm your decision. If it seems too good to be true, it’s
probably too good to be true.
- No matter how chosen, special,
or select a group you’re in, no matter how exclusive the club you
belong to, continue to ask questions. His creation of exclusivity
obviated questioning by the time a client was accepted. Jerry
Oppenheimer in his book, Madoff
With the Money
(the best title for a book since adolescent psychologist Dr. Anthony
Wolf’s Get Out of
My Life, But First Could You Drop Me and Sheryl Off at the Mall)
noted that Madoff
surrounded himself by associates and staff who would not question
him.
- Be willing to sleep on it.
There are few true emergencies in life, and investing is not one of
them.
- Following the lead of famous
people into an investment is meaningless unless they became famous
by investment success.
- Three basic tenets of good
writing apply to good investing: clarity, brevity, and simplicity.
Madoff had a complex investing scheme that even other money managers
admitted they didn’t understand.
- You are the CEO of your own
finances. It’s an ongoing job.
- The logic of financial decisions
resides at a different neural address than the pleasure center.
Since our brains are wired for instant gratification, reason can be
hijacked and held hostage—unless
there’s a plan and you stick to it.
- When a stock portfolio does
well, someone may attribute this to talent and smartness. And it
could be. Or not. My wife and I play heads-up poker, and she
finally confessed that one of my “tells” is that when I happen
to draw a really lucky hand, I have an smug look like I think I’m
brilliant.
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