My brain is my enemy (updated 2/9/15 original 10/3/12)

The chronicle of higher education ran a fascinating article on the impact of our brain chemistry and function on our investing decisions. I have long feared the impact of emotion when it comes to trading. This work appears to support the research in Thinking Fast and Slow by Daniel Kahneman, which outside of the Bible is the most important book I have read in my life. So what can we do?

We will never be S'chn T'gai Spock, the Star Trek commander that always used logic, never emotion. A suggestion in Kahneman's book is to establish rubrics or decision trees. So this is one thing I try to do in investing. I have learned that nearly all of the online brokerages treat you the same if you have $2,000 invested or $20,000 invested, the trade fee is usually the same, access to research usually the same and so forth. So, we can put our investment money in several different online brokerages trying to take advantage of their various strengths.

 So, we introduce the notion of baskets. A part of our total investment and it has some ground rules. And every investment decision has to be part of the ground rules. Let's talk about some simple examples:

All small caps, or all mid cap, or all large or mega cap. The advantage to doing this is from time to time in bear/bull cycles one or another size does better. By having them all together you can compare apples to appls.

All emerging, or all international, or or or

All &lt 5% debt to assets Easy to understand, but fairly primitive, but as we grow our experience and our portfolios, we can combine rules:

All pacific, except no Japan, mid-cap

All US, &lt 5% debt to assets, top 3 performers in the basket get $500 added every trading cycle Why is this important? People that are new to investing will commonly skip the idea of having a significant foundation of ETFs that are index based and jump straight to the idea of finding the "hot stock" ( or ETF). And sometimes Mr. Market and their intuition will reward them. Sometimes they have legal insider knowledge as customers of the product. But that approach will eventually and utterly fail as they purchase individual stocks of things they read about in Money Magazine or whatever. Instead, we know that our brains, at least the thinking fast part, are well designed to take us into bankruptcy.

I have been using this basket/ground rule strategy for several years and it has worked out for me to help protect me from impulse buys. It also helps me mark the point at which a strategy has to change or simply is not working out. 

As an example, I have a paid service, (expires in June 2015) called the Motley Fool Million Dollar Portfolio (MDP). The ground rule was very simple, if they said buy and make it a 4% allocation in the basket, that is exactly what I would do. Same for sell directions. Then they had a staff turnover, Ron Gross has left, a new team with a new philosophy has come in. There was minimal explanation of what was going on, but a lot of sell and partial sell orders. The new philosophy is to look at other Motley Fools paid services and recommend the best picks. The problem with this is I am already overweight with respect to the Motley Fool. I have their mutual funds, when I look up a stock on Google Finance, there is almost always a pointer to at least one Motley Fool article. Nothing against the Fool, MDP is my best performing basket even though the service launched right as the great recession started. My first inclination was to say the heck with this and unsubscribe. And that is a fantastic illustration of my brain reacting to information. From now, until my subscription expires I am going to run a fake portfolio with their recommendations, but I am going to relax the ground rule of this basket. In June I have several decisions to make and now is the time to lay the groundwork.

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