It seems ridiculous, but is it really possible for somebody with brain damage, which affects the decision making parts of our brain, to beat the average investor and many professionals?
A team of academics started a simple game. Starting off with $30, you would risk $1 on a coin flip (or pass and risk no loss) if the coin came up as tails. If the coin came up as heads, you won $2.50.
So a 50/50 chance of gaining $2.50, and a 50/50 chance of losing $1. The game lasted for twenty rounds.
People with ‘normal’ brain functioning were reluctant to bet, even though the chances of winning were much greater than 50%, due to the extra $1.50 on offer for winning.
Or put another way, if you won on 10 rounds ($25 gained), and lost on 10 rounds ($10 lost), you would be up by $15. Even if you lost on 12-13 rounds, you would still be up. So the rational decision would be to bet on every round.
What is interesting, is that they were most likely to stop flipping the coin after experiencing a loss in the last round – ‘once bitten twice shy’. The pain of losing $1 discouraged these people from trying to win $2.50.
In comparison, the people with brain damage that included damaged emotional circuits bet on around 85% of rounds, even when they had previously lost $1 in the previous round.
The result? The people with brain damage outperformed by 13%-15%! In investing, many professional investors lose money, relative to the market, because of the fear of losses as well.
That doesn’t mean we should all hit ourselves over the head with a sledgehammer to get better investment results.
But it merely shows that the fear of losses is lurking in our brains, and overcoming this fear can increase your returns more than simply having great investment knowledge.