Now the client didnt have to see that offensive LOSS and was happy. This may seem silly, but Professor Richard Thaler has shown that most people exhibit some form of this irrationality in what he calls mental accounting.17 We might, for example, be willing to borrow money on our credit cards at 18% while keeping a savings account that earns 2%. A rational investor wouldnt keep such separate accounts, but rather would pay off the credit card debt with money in the savings account.

Even when there are no real accounts, people tend to keep separate mental accounts for their money, and this can create costly irrationalities. For example, I was out one evening shopping with Patricia. She found some costly cosmetic cream at the swanky store called Sephora. The cream cost $135 for a small tube.

Are you going to buy the cream? I asked. Patricia said yes, but then added Ive spent too much money today. Ill come back tomorrow morning and buy it. Patricia kept a mental account for each days spending. This informal accounting system caused her to spend extra time, use extra gas, and pay an additional parking fee to acquire what she could have purchased immediately.

Like all people, I tend to maintain mental accounts, and it has hurt my investment performance. Beginning in early 2002, I started buying stock in some gold mining companies. I thought that the Federal Reserves easy money policy might lead to a rise in gold prices, which in turn would increase the profits of gold mining companies. Accordingly, I invested a small amount in these stocks.

How did I do on my gold investment? Since my initial purchase, the price of gold has risen by more than 50%, and many gold mining stocks have doubled. So I was absolutely correct with my decision to buy gold. Unfortunately, I made absolutely zero on my investment.

Why did my trading so completely fail my analysis? The answer was that I was buying gold stocks in an account that had nothing else in it except for some inflation-protected bonds. Gold mining stocks can be pretty volatile. So whenever gold declined, I saw this account shrink dramatically in value. This made me feel like an idiot, and I tended to sell the stocks at exactly the wrong time.

I was suffering from a form of mental accounting. Gold is a hedge against inflation. Most of us will be far better off in a world where gold prices are low. So in periods when gold was dropping, my prospects were improving. When gold went down in price, my overall position looked like:

Gold investment LOSS

Non-gold investments GAIN

Total GAIN

So I should have been happy when gold went down. The solution for me is the same as the solution for Nassims clients. I now make sure that I look at my overall position. In the past, I had tended to look at each account separately. Now I force myself to use financial software to look at my total position.

So the lesson is we need to perform some spin control even for ourselves. We have to guard against goading our lizard brain to become active (and destructive). That means we should anticipate what sort of information would push us toward emotional decisions.

Conclusion: Look at your financial position in an aggregate fashion. In particular, be sure to combine any defensive positions with other investments that are being protected.

Lesson #7: When to Go All In

My buddy Chris, the MIT rocket scientist who we met a couple of times, is a world-class ultimate Frisbee player. This rapidly growing sport combines elements of soccer and American football.

Chris was a key member on the Boston-based team Death or Glory (a.k.a. DoG ) that had a dynastic hold over the sport both in the United States and internationally for many years. In the world championship in

1996 Chris scored eight goals as DoG defeated Sweden 21-13, with seven of these goals being almost full field passes; the equivalent of a long bomb in football.

How did Chris become one of the dominant offensive players in the world? Interestingly, although scoring requires outrunning the defender, Chriss success is not the result of speed. Although Chris is speedy, he often plays against others who are faster. Somehow he is able to score consistently on faster defenders and he dominates competitors with equal speed.

I asked Chris his secret. How do you outrun people who are faster than you? His answer, I maintain the ability to make at least two different moves. When I get a slight advantage, I commit completely.

At almost all times, Chris is not running at full speed. Rather, he is jockeying for position, and carefully watching for an opening. This can come in some subtle form such as noting that the defender is leaning in such a way so as to be unable to react to a move in a certain direction. At that point, Chris is all in, sprinting at full speed.

In contrast, less experienced players are often running hard almost all the time. They look like they are doing well, but they do not score very often. These less successful players expend lots of effort and receive little reward.

There are some similar themes in investing. Many people tend to be all in, all the time. By this I mean that they have maximum capital at risk every day. In fact, the standard advice from Wall Street is to invest most money in stocks. An investor who follows this advice is fully committed to a risky course all the time.

In bull markets, being all in is very profitable, but problems surface when markets decline. Remember that Chris always maintains at least two options for his move. In contrast, investors who constantly put all their money at risk are not in a position to buy more at moments of irrationally low prices. By being fully committed all the time, investors remove the ability to buy more-they no longer have two viable options.