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How to Avoid Getting Cheated by Bad Investment Advice

“Come what may, I will not listen to anyone’s advice before investing my money this year,” said my friend Ravi. “I’ve had enough of bad advice last year!”

“Is this your New Year resolution?” I asked him.

“Yes! And this time I am not going to break it!”

“Let’s see,” I said while infuriating my friend who thought I did not believe he was really going to adhere to his resolution this year.

“See Ravi,” I told him, “I don’t want to disappoint you. But you have to go past a great obstacle to meet your resolution of not falling for your advisor or broker’s advice.”

“What do you mean?” he questioned.

“Okay, let me be very clear with you now.”

“You better be,” he chided me as if warning me against confusing him with my explanations.

“See Ravi, if you’re wondering why you’ve ever listened to dubious advice from your broker or financial planner, there is a study done by a leading neuro-economist that suggests it’s really hard for us to resist the temptation to fall for someone else’s advice.”

“And who’s that?”

“He’s Dr. Gregory Berns of Emory University in the US. Dr. Berns works as a Professor of Neuroeconomics, and in 2009 published a study that illuminates what happens when we listen to an ‘expert’ we trust.

“Tell me more,” Ravi sounded as if he was interested to listen more.

So here is what I told him.

How Our Brain Works
Let me talk about an experiment Dr. Berns did along with his colleagues. He asked people to pick between a sure win and a series of gambles. A functional magnetic resonance imaging (MRI) scanner tracked the changes in blood flow in their brains as they made their choices.

In 50% of the instances, an ‘expert economist’ with impressive credentials suggested which option was better; otherwise, people made up their own minds.

When people had to think for themselves, two networks in their brains activated.

One that determines the payoff from a sure win, and one that that calculates the likely gain from a gamble.

These are the areas of our brain that normally make decisions by combining the value of:

  1. What you have,
  2. Your fear of loss, and
  3. Your hope of gain

However, something interesting happened when people that were part of the experiment listened to the expert’s advice.

The activations in their brains faded! In simple words, the three bulbs that earlier lighted up (bulbs of – what I have, my fear of loss, and my hope of gain), did not light up when people listened to the expert’s advice.

Amazingly, these bulbs stayed quiet even when the expert’s advice was bad!

Dr. Berns’ concluded that when we make financial decisions on our own, our brain’s regions for evaluating risk and reward are active.

But when we take advice from an expert, two things happen:

  1. The networks in our brain that earlier alerted us on what we had, our fear of loss, and our hope of gain, do not get activated, and
  2. Our choices move toward whatever the expert recommends.

In short, Dr. Berns’ summed it up that…

“…the mere act of seeking an expert’s opinion may erase our own. In the presence of a financial advisor, our brain can empty out like a dump truck.

Our brain empties like a dump truck in the presence of an ‘expert’

Now you can imagine what happened to all those sophisticated clients of Citibank in Gurgaon who lost crores at the hands of just one Shivraj Puri a few years back.

These were highly educated people and at high positions in the corporate world. But their brains failed to fire up just because they were mesmerized by the advice – and the promise of high returns – from their relationship manager, which led then to huge losses.

As Dr. Berns puts it…

You should beware of people offering advice not only because they might be wrong, but because that advice may inhibit your own ability to form judgments.

“So does that mean we must never listen to a financial advisor? I think that’s a good idea.” Ravi broke his silence.

“No Ravi, not at all!” I told him. “None of what Dr. Berns suggests means that consulting with a financial advisor is an inherently bad idea.”

“But you just said that,” he countered.

“I never did. I never said that consulting with a financial advisor for your investment plans is a bad idea all the time.

“What I’ve tried to tell you is this. If you have strong beliefs about what investing strategy is right for you, you should write down your reasons for those beliefs before you sit down with an advisor.

“And then, when you meet or speak with the advisor, commit to no course of action that makes you uncomfortable. Only after you have had a chance to review it later, away from the direct influence of the advisor, should you accept or reject any major change of strategy.

“You see Ravi, some advisors are sometimes right and there are some who are often right. But the responsibility is upon you to determine whether you agree with your advisor once your brain is clicking again, and not when it is acting like a dump truck mesmerized by what he advised.

“After all, even he is a human being and even his brain works with the same constraints as yours. Don’t treat him like a super-human, and keep your brain on alert mode when he is advising you stuff.”

I saw a tinge of smile on Ravi’s face.

“All the best, Ravi! I wish you keep your New Year resolution this year!” I said while bidding him goodbye.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Exactly Vishal,
    I can also think of misselling of many insurance policies.on the similar line.
    Many are the victims of misselling of insurance like Endowment policies by the advisors

    Satish Mruthyunjaya

  2. T K Krishnan says:

    Now I know why we-no our brains (ah!)- rush to put our money into many recommendations with little thought.
    This behavioral explanation is so simple and a practical use of neuro psychology.
    Grateful for telling us such nuggets.

  3. Pankaj Agrawal says:

    Hi Vishal,

    I have been following your posts for a while and have always found a thing or two to add to my reservoir of personal intelligence. Here I would like add a point hoping you won’t mind me adding something to your blog.
    A few months back I got into taking advice on stock investment and it happened that the very first advice I took bore good results, however the second advice which I took injured my portfolio badly. The time I took the second advice I had doing my own research and knew myself that the investment was not good enough. But as the advice had come from a great source with great historic success record, I started looking for positive advice on the same stock from other sources in order to take the call. Here inspite of having understood the investment wasn’t good for me I went ahead and put my money into it.
    The point here I am trying to make is about “confirmation bias” which a person not only does for his own decision but also for the advices of other people or the so called experts.

    Pankaj Agrawal

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