puzzled, however, when his training consists of performing household chores. For example, he spends many hours polishing Mr. Miyagis cars using a particular wax on, wax off technique. In a frustrated confrontation with Mr. Miyagi, Daniel is surprised to find that the cleaning techniques are actually karate moves.

Similarly, we answer Adams question by first addressing core principles and later applying them to bonds, stocks, and real estate. The conventional wisdom is based on a view that people are nearly perfect decision makers. Sane investors, the rational view suggests, would buy risky stocks only at prices low enough to promise a high return. Thus, the standard advice to buy stocks is based on the assumption that market prices are rational. If markets are crazy, however, then the buy stocks for the long run message might be wrong. To know where to invest, therefore, the first step is to investigate rationality.

Are people really cool-headed robots who calmly evaluate financial opportunities according to the maximizing rules of calculus? There is one place in the world where people do act this way; that place is economic theory. The standard assumption in economics is that people make such good decisions that our choices are labeled as optimal. Conventional investment advice is based on this underlying belief that people and financial markets are rational.

In the real world, however, people are far from rational. Perhaps my own most poignant lesson came in a battle with a wedding photographer. After taking the pictures of our wedding, Juli the photographer would not give us our pictures. I appealed to Julis morality and to her self-interest with a variety of sophisticated tactics to get our photos. I even offered to pay additional money. To all these rational tactics, she never responded. After Juli spent some time in jail, however, she relented and gave us our negatives. Was her behavior rational? No. She gained nothing from her obstinacy and suffered severe penalties. Is such irrational behavior common? Yes.

People are crazy. While we all know this, the investigation of the economic implications of irrationality began in earnest only in the late 1970s. Professor Daniel Kahneman, along with the deceased Professor

Amos Tversky, began the rigorous documentation of human decisionmaking errors. In 2002, Professor Kahneman shared the Nobel Prize in Economics for this new scientific approach to irrationality with my graduate school advisor, Professor Vernon Smith.

Investment advice has not kept up with cutting edge intellectual developments. While the science of irrationality has grown up, the conventional wisdom still provides investment advice based on outdated theories of sane people and rational markets.

Wax Off: Meet the Lizard Brain

Behavioral economists have proven that our financial decisions are often irrational. The obvious question is, why have we been built to be so bad at such important tasks? To find the underlying rationale for irrational behavior (which turns out not to be so crazy in some respects), we have to look beyond standard behavioral approaches to some groundbreaking work in other fields.

An important source of our troubles lies in the discord between our modern world and that of our ancestors. We are built to solve ancestral problems, and sometimes this gets us into trouble. Some of the most compelling examples of these insights come from medicine.

Consider that babies who breast-feed exclusively need to take vitamin D supplements or risk serious health consequences.5 Nothing would seem to be more natural than to feed mothers milk to a baby. Why are we built to cause sickness in our children? The answer is that we (both as adults and as babies) manufacture vitamin D when we are hit by sunlight. People who spend a lot of time outdoors, particularly in places with strong sunlight, make plenty of vitamin D. The babies of our ancestors got enough outdoor sunlight to be healthy. Many babies (and their moms) today, however, stay indoors or out of direct sunlight to avoid skin cancer, so our natural-born system doesnt work. Thus, our babies get sick because we live differently from our ancestors.

A similar logic is found in the prevention of heart disease. Men, in

particular, are told to take an aspirin a day to thin blood, reducing the risk of heart attacks.6 Why dont we produce blood that has the correct viscosity? The answer is that thick blood heals wounds rapidly. Our ancestors had frequent wounds, and most died too young to worry about heart disease. Thus, our blood is too thick for us because it is built to protect us from the ravages of an ancient world where people were often wounded and died young.

So what does all this have to do with our financial decisions? Our brains, like our bodies, reflect the world of our ancestors. In particular, our lizard brains are pattern-seeking, backward-looking systems that allowed us to forage successfully for food, and repeat successful behaviors. This system helped our ancestors survive and reproduce, but financial markets punish such backward-looking decisions. Consequently, our lizard brains tend to make us buy at market tops and sell at market bottoms.

In Pitch Black, a sci-fi film featuring Vin Diesel, a group of inter-galactic travelers crash on an ominous planet. They soon learn that the interior of the planet is filled with vicious creatures. The good news is that the creatures cannot arise in daylight, and because the planet has multiple suns, eclipses are many years apart. The bad news is that the next eclipse, with its consequent destruction, is coming in just a few hours.

Similarly, there is good news and bad news for the role of the lizard brain in our financial decisions. The good news is that the lizard brains influence on our financial decisions is only disastrous in some particular and rare circumstances. The bad news is that we are living in one of those dangerous environments today. For the last several decades, we have enjoyed the benefits of several powerful, but unsustainable, financial trends. Our backward-looking lizard brain is most likely to impoverish us in precisely these sorts of environments. In a sense, we now face the meanest of financial markets, almost cruelly set up to frustrate and to cost us money.

Just as we can live longer by understanding the basis of our medical problems, we can make more money by understanding and taming the lizard brain.