The central question of Mean Markets and Lizard Brains is, Where should I invest my money? The conventional answer is that those who seek high returns must take high risk. For a patient investor with some tolerance for risk, conventional wisdom says to buy stocks.

This conventional wisdom makes sense, however, only if stock prices are not irrationally high. Those who believe in the efficient markets hypothesis claim that stock prices are always correct. The conventional wisdom is based on the assumption that markets are rational, thus stock prices cannot be too high. If markets are crazy, however, the best investments might be radically different from those suggested by the conventional wisdom.

Thus, in order to decide where to invest our money, we must first evaluate the idea that markets are rational. We do this in two parts. In Chapter 2, we ask whether people are rational, and in Chapter 3 we ask whether groups of individuals interacting in financial markets are rational. We will conclude people are not rational, and markets are often crazy.

In this section we meet the lizard brain-that part of our financial decision-making machinery that costs us money. We will find that we are built with a backward-looking, pattern-seeking brain that tends to make us want to buy when prices are irrationally high and sell when prices are irrationally low. We are built to be exactly out of sync with financial opportunity.

chapter two

CRAZY PEOPLE

Lizard Brains and the New Science of Irrationality

Do Not Be Afraid to Meet the Lizard Brain

Boy, the food at this place is really terrible...Yeah, I know, and such small portions. Well, thats essentially how I feel about life. Full of loneliness and misery and suffering and unhappiness, and its all over much too quickly. So says Woody Allen in the role of Alvy in the opening scene of Annie Hall.

Similarly, our rational skills for finance are simply terrible, filled with systematic errors and biases. As with Woody Allens punch line about not getting enough bad food, we use our limited analytic skills far too rarely when we make financial decisions. As bad as we can be at making financial decisions with the more rational parts of our brains, we get in even more trouble when the lizard brain starts calling the shots.

In this book, I divide the human brain into two parts: the prefrontal cortex and the lizard brain. This is a dramatic simplification of an extremely complicated reality. Most, but not all, of what we think of as

abstract cognition occurs in the human brains prefrontal cortex. The term lizard brain includes many important human brain regions that have nothing to do with reptiles.1

Thus, lizard brain is shorthand for an important idea. It is used in the spirit advocated by Sir Peter Medewar, a scientific expert in the study of aging, in his famous article, An Unsolved Problem of Biology :

Being in some degree crippled by the handicap of trying to be intelligible, I am bound to make statements which, if not baldly wrong, are true only with qualifications which I shall have not time to give them. This disability is not to be avoided; one gets nowhere if every sentence is to be qualified and refined.2

Similarly the lizard brain is a term that I grew to use while conducting research with my Harvard Business School colleague Professor George Baker. I continue to find it productive even in discussions with experts in behavior and cognition. Because the reality is complicated, however, we must remember that lizard brain is verbal shorthand for the less cognitive, less abstract, mental forces that influence human behavior, most of which have nothing to do with lizards.

The lizard brain is great for finding food and shelter, but terrible at navigating financial markets. Many financial problems occur when we use the lizard brain to make monetary decisions. Instead of using the analytical part of our brain, we often default to older parts of our brain that helped our human ancestors survive for tens of thousands of years before financial markets were created. The lizard brain is not stupid, but when confronted with problems never experienced by our ancestors it can make us look crazy and cost us money.

Before we investigate how the lizard brain leads us astray in financial matters, we must first deal with another human universal: Criticism is unpleasant. Being told that we are bad at something is, for most people, about as enjoyable as a mild electric shock. As a professor, I see this with my MBA students on a daily basis. At the Harvard Business School we follow the Socratic method and an integral part of that technique is getting