An amazing number of athletes have suffered a devastating loss of form right after making the cover of Sports Illustrated magazine. This phenomenon has become known as the Sports Illustrated Jinx.

To understand this “jinx” we need to go back in time to 1885 when Charles Darwin’s cousin, Sir Francis Dalton, was doing experiments with sweet peas. He found that the seeds of unusually big plants produced offspring smaller than themselves, while seeds of unusually small plants produced offspring that were a bit bigger.

And back in the 1960s the psychologist, Daniel Kahneman, was coaching Israeli flight instructors. Kahneman was explaining the benefits of reward over punishment as an effective training method. But the instructors disagreed that encouragement was a consistently good motivator. They argued that if they praised a cadet for a particularly good flight his next attempt would often be worse, but when they yelled at a cadet who’d messed up a manoeuvre he’d invariably do better next time.

You'll feel better in the morning

The truth is that there is no jinx on the Sports Illustrated cover, and without a doubt reward is a far better motivator than punishment. What’s really going on is the universal phenomenon of “Regression to the Mean”, which Sir Francis Dalton went on to articulate: things return to their average; they revert or regress to their mean. An unusually strong performance will sooner or later be followed by a more average one (it will revert back DOWN towards its average), and an unusually poor performance will be followed by a more average one (it will revert back UP towards its mean).

Sir Francis Dalton found the regression phenomenon applied not just to sweet peas, but to humans: very tall fathers produce sons who are not quite as tall, and very short fathers produce sons who are not as short. Regression to the mean is a law of the universe. Otherwise, as he pointed out, we’d live in “a world of giants and midgets”.

Athletes appear on the cover of Sports Illustrated when their performance is extraordinary. So, due to regression alone, we can expect this extraordinary performance to be followed by a more ordinary one. And regardless of whether the Israeli flight instructors yelled or praised their cadets, by the fact of regression to the mean a shocking flight is likely to be followed by a better one, and a superb flight by a worse one.

The human brain really struggles to get a grip on regression to the mean. (Regression theory was only formalized two hundred years after Newton had worked out the law of gravity). Humans struggle to accept regression because we’re subconsciously wired to link up events with cause-effect explanations. In fact, neuroscientists have shown that a particular part of the brain releases a pleasant-feeling chemical at exactly the moment we conclude, “This caused that.” We like to link things up. So when we see what is in fact regression (improved flight), we try to explain it with an external cause (yelling at that cadet made him do better).

Regression does have explanation (what goes up, comes down; and what goes down, comes back up) but it doesn’t have a cause that we can attach to it – it’s just how the universe works.

Stock market prices, golf scores, daily temperatures, and sore backs all regress towards the mean. Doctors know all about this. That’s why they hand out aspirins and tell you to come back in a few days if things aren’t better.

The problem is that investors who don’t recognise regression will suffer from the psychological flaw which Behavioral Economists call “Recency Bias”, which is the tendency to expect that what has most recently happened is likely to happen next. So when markets have fallen investors expect them to keep falling, and to keep rising when they have recently risen. Regression blindness also leads to “Representativeness Bias”, or expecting exceptional results to continue as if they were normal (or average).

Both of these biases hamper the process of buying low and selling high. They cause investors to mess up by pessimistically selling when markets are down and euphorically buying when prices are high. Just look how regression-blind investors frantically dumped Asian and Emerging markets stocks in 2011 (down -19% for the year), while now, just two months into 2012, these same markets are this year’s top performers, up +15%.

Regression to the mean permeates our lives. My Gran understood it well. When I was upset she’d tell me to go to bed. “You’ll feel better in the morning”, she’d say. “Tomorrow is another day”.

In the short-term, on those days you do feel down, it’s good to know that your feelings will indeed climb back up to your long-term-average level of happiness. So will global markets – the world has recovered from countless calamities, natural disasters and two World Wars. Regression to the mean is a very comforting law of the universe. And understanding it will make you a much better investor.

You’re sitting in front of a red light and a green light. Every 4 seconds either the red or green light will flash, and your job is to call out which colour you think will come up next. The only clue you have is that out of 100 flashes, 80 will be green.

Meantime, I’ve set a pigeon the same task in the room next door. Since pigeons can’t call out colours, birdseed gets released when the pigeon correctly pecks the light that flashes next.

When this experiment is done in the lab, humans typically guess right 68% of the flashes. But pigeons always score higher than humans. With 80 out of 100 flashes being green, the simplest way to score more than 68% is to call “Green!” every time (you’d automatically get 80% correct). Pigeons quickly cotton onto this, and doggedly keep pecking the green light because they realise that’s the surest way to get the most food.

Humans doing this experiment just can’t help shouting out “Red!” every once in a while.

No one fully understands the powerful psychological forces that fuel this human desire to gamble. In Hong Kong, stockmarket punters have taken it to a whole new level via the equivalent of a betting slip dressed up under the fancy label of “Callable Bull/ Bear Contract” (CBBC). Known on the street as “bulls” or “bears”, these leveraged derivative contracts let punters bet on the daily direction of a stock, or even the Hang Seng Index; buy a bull if you think today will be an up day, or buy a bear if you’re guessing down. Exciting, yes; intelligent, no. If the market moves opposite to your guess that day, the contract is “recalled” and your money’s gone (as punters say, “Ai-yaa, my bull is dead!”). When the Hang Seng Index slipped 5% on 22nd September, punters who bet on a rise saw more than HK$ 100 million evaporate that day.

Still, these losses haven’t dampened the Hong Kong punter’s unquenchable thirst for gambling. In 2011, bull/bear betting ballooned 49.9%, reaching 24% of total stockmarket turnover. And as the world lurched through the thick of the Euro crisis in November and December, Hong Kongers gambled harder – turnover of warrants and bull/bear contracts soared to 40% of market turnover in those two months.

On one Wednesday the Hang Seng Index first swung over 19,100, knocking out the bear contracts, then whipped back the other way to knock out the bulls. The Index ended the day pretty much where it started, at 19,066, albeit leaving thousands of flummoxed (and poorer) punters in its wake.

A more intelligent strategy for making money is to invest like a pigeon: bin those betting slips and keep calling green. It’s simple: drip-feed money into a market which is low now but has the best odds of reaching a higher level down the road. (Asia and Emerging Markets would be a sensible choice, seeing as the middle class population of these regions is set to swell by a billion consumers over the next twenty years.) This tried and tested strategy is known as Dollar Cost Averaging (DCA for short). To be absolutely clear WHY it works so well, watch our short explanatory video here.

To invest like a pigeon you need to play the probabilities in your favour. Give some intelligent thought to which areas of world markets are most likely to rise above the level they’re at today, and then keep pecking at that green light with your monthly savings. That’s the way you’ll be sure of getting the most food down the road.

George Elliot wrote, “That quiet mutual gaze of a trusting husband and wife is like the first moment of refuge from a great weariness or a great danger.”

The good news is, much of the same benefit can be gained from your pet. And it’s true – I feel very calm, happy and content when I cuddle Mrs Mooncake’s furry little ears and tickle under her chin. In fact, gazing at her sweet face, I have to say I even feel like a wiser, better person.

Well, scientists have solved the mystery – cuddling your pet triggers the release of a hormone called oxytocin (also known as the “cuddle drug”). It travels out from your pituitary gland and into your blood system, causing those warm and mushy feelings we know so well.

Of course, nature always has a purpose. Scientists first studied oxytocin in mothers and discovered that breast-feeding, oxytocin-fuelled mothers experience feelings of similar intensity to a cocaine high. This keeps mums at it, and babies well-fed.

Oxytocin is the reason we develop an attachment to things we’re around for a while, whether it be Mrs Mooncake, a person, or even a thing. The more you’re around that object, the more oxytonin is released and the more attached you become. Behavioral Economists have given this trait of attachment the somewhat clunky name of “The Endowment Effect”. Simply put, this means that once you own something you’ll automatically start to value it more than others would. That’s why we like our own stuff, and why it’s so hard to throw out your favorite pair of old jeans – oxytocin causes “sentimental value”.

Companies, shares and investments can also activitate oxytocin in our brains. This can make you feel attached to specific investments, particularly if you chose them yourself. This is why a lot of people have a “bottom drawer” of investments collected over the years that really should be given a good spring clean and repositioned; things like decimated dot-com stocks from the 1990s, neglected pension funds from earlier jobs and – the most difficult of all – investments received as inheritance from a beloved member of the family. In Behavioral Finance, the Endowment Effect goes hand in hand with “Status Quo Bias”: the reluctance to make changes. Oxytocin-fuelled attachment is at the root of it all. Spring cleaning your collection of investments can feel as unappetizing as getting out the bin bags to sort through your wardrobe. But both need to be done on a regular basis – and you’ll always feel better afterwards.

Dose up on oxytocin for calmer portfolio decisions

Oxytocin is both a nuisance and a help when you’re investing. It’s a nuisance when it creates unhelpful attachments to investments that need to be sold, but it’s helpful because it can calm you, in the way you feel when you sit with your cat on your lap or your dog by your feet. It’s always preferable to make decisions in a calm state of mind. Panic selling happens when investors are in, well, a panic. Scientists have found that injecting a dose of oxytocin into highly stressed animals quickly calmed them. Imagine if regrettable, panicky actions could some day be avoided by swallowing an oxytocin pill to calm those destructive stress hormones!

Still, the day hasn’t yet come when investors can pop into the pharmacy to pick up a pack of oxytocin tablets in preparation for a clear-thinking portfolio review. In the meantime, use your knowledge of oxytocin to help yourself make more rational investment decisions:

• Investments can activitate oxytocin in your brain, making you feel attached to particular holdings.
• This can make it difficult to tidy up your portfolio when you need to, so keep on the lookout for oxytocin-attachment when you’re feeling stuck.
• Proactively tackle Status Quo Bias by making regular portfolio reviews a habit.
• And if you’re watching or reading financial headlines at home, be sure to have your oxytocin-generating pet on your lap or at your feet, to calmly keep you from jumping up and doing something you’ll later regret.

There’s a lovely story about this cowboy out in Texas. He paced out a hundred yards from a barn, spun around, and fired six bullets across the wall. Then he jogged back to the barn and painted six targets, positioning the bull’s-eyes directly over each bullet hole.

Another cowboy up on the ridge heard the shots ring out and galloped hard across the plain to see what all the shooting was about. But, when he saw the bullet-holed targets, he decided not to mess with the first cowboy, who was, apparently, an incredibly good shot.

Our brains are constantly on the hunt to link up “causes” and “effects”. Linking events in a cause-effect relationship makes us humans feel we’ve got a grip on all the things going on around us. In fact, neuroscientists have shown that a particular spot in the left hemisphere of the brain lights up at the exact moment our brains pronounce, “This caused that.”

These neurological activations are so swift that they often link two events based on nothing more than coincidence. (That’s where superstitions come from: black cats cause bad luck, crossed fingers cause good luck, etc). This impulse to link two events in a cause-effect relationship, without actual proof that the one caused the other, is called “Magical Thinking”. Like this:

• Stocks Close Lower After Debt Drama
  Blue chips stumbled as Standard & Poor’s downgrade General Motors bonds. The Dow Jones Industrial Average ended down 0.43%.

The journalist who wrote the headline has got all muddled up between coincidence and cause-effect. Market prices are the moment-by-moment result of exchanges between literally billions of people, each busily buying and selling with their own objectives and investment timeframes in mind. Statistically, a 1.4% daily movement (either up or down) falls squarely within the range of randomness for financial markets i.e. a perfectly normal daily variance as a result of all this buying and selling. So any movement less than 1.4% is what scientists call “statistically insignificant”. It’s just random. It’s pointless to try to explain a random result; a bit like trying to explain why a coin landed heads.

Most days, market movements are just random and statistically insignificant. Of course that makes it tough for financial journalists who are trying to earn a living by reporting newsworthy events. Not surprisingly, they like to liven things up by linking boring (statistically insignificant) daily price movements to more interesting events which happened to occur on the same day elsewhere in the world. I collected these kinds of headlines for years. Here are a couple of my favourites:

• Markets surge on news of Saddam’s capture
  S&P 500 up 0.9%

It’s a nonsense headline because, as we now know, any movement under 1.4% is a perfectly normal random market variance, so can’t be explained by a cause-effect connection. (A quick way to check for a true cause-effect relationship is to reverse it: if the “cause” hadn’t happened, then would the “effect” then definitely not have happened either?)

I love this one:

• U.S. hedge fund jitters rattle Asian shares
  Falls in U.S. stocks weighed on Asian markets as investors moved into the safety of government debt on rumours of hedge fund losses. Markets in Hong Kong, Singapore, Taiwan all down by 0.2%.

What a load of gobbledygook. But now that you see how it works, you can have a go at a few yourself. Take an interesting event (involving well known global personalities if you can), add a couple of evocative verbs, and link them up with a daily market movement. Like so:

• UK shares soar 1.1% with Royal Wedding as joyful nation celebrates double balcony kiss

• Nervy markets dip 0.8% as Obama submits his application for annual leave

Watching financial journalists paint bull’s-eyes on daily news events can be a good laugh once you’ve got the hang of it, but there’s really no need to take this kind of cavalier reporting seriously.

Book your seat for The Psychology of Successful Investing seminar, Wed 25^th May, at The China Club, Hong Kong. Full details and bookings here.

Alice is training for a race so she runs in the early mornings. But last night she couldn’t stop watching Mad Men, so she only got to bed at 1am. She felt dreadful when she was tying her laces at six this morning – but she’s feeling great now, because she did it.

There are two separate decision-making systems in our brain. They’re both designed to help us make decisions which will bring us pleasure and avoid pain.

Your instinctive decision-making system is interested in the here and now (bed is cosy/ running will hurt). It’s always ‘on’, so it kicks in immediately. Your analytical system is the part of your brain that thinks things through. Unfortunately, its default mode is ‘off’, so you have to consciously turn it on to override your instinctive reactions. You click it on to work through a spreadsheet, put a report together, or to remind yourself the reasons why you’re lacing your running shoes at six in the morning.

Obviously, what’s pleasurable in the short term isn’t always best for you down the line. And decisions that seem tough now can produce outstanding results later. That’s why these conflicting decision systems so often get investors into trouble. Everybody knows that you need to buy assets that are cheap now so you can sell them for more money later. But human instincts shy from low prices (keep away from those!), and are thrilled by rising prices (get some more of that!). So executing a profitable long-term investment strategy requires many of the same mental qualities needed to stick to the healthy discipline of early morning runs.

Just Keep Doing It

Runners use a number of strategies to get themselves on the road:
- They make it automatic
Runners schedule specific times to run, on specific days of the week. Since we all find pleasure in productive routines, this “reprograms” the pleasure/pain instinct. Getting up to run feels good now, not bad.

- They know a lot about it.
Humans get a great deal of pleasure from knowledge. If you’ve ever met a runner, you’ll know they can talk for hours about the art and science of running. Most runners proudly own a small personal library of books about running. People like doing things they know a lot about. This keeps runners running.

- They focus on the excellent long-term benefits
A quick Google search reveals dozens of forums dedicated to listing and explaining the very real physical and mental benefits of running (101 Reasons to Run, Running’s Great Life Lessons, and so on). Articulating these benefits “turns on” the analytical part of the brain, overwhelming the instinct to stay in bed.

You can use the same techniques to keep your investment life on track. Dollar Cost Averaging is a highly effective, tried-and-tested investment methodology that does exactly that. Used properly, it will optimise the impact of your monthly savings on your long-term financial wellbeing.

This video explains how and why Dollar Cost Averaging works. After watching it I’m confident you’ll:
- See how to make it automatic
- Know a lot about it
- Understand the excellent long-term benefits

Don’t miss our upcoming seminar, The Psychology of Successful Investing at The China Club in Hong Kong on 13th April. Full details and bookings here.

The CapGem analysis also shows that most millionaires aren’t born into their money; only 16% have inherited their wealth. The vast majority have got there through hard work, discipline and prudence. 47% are successful entrepreneurs, and 23% are hard-working professionals or managers who’ve diligently saved and invested a lifetime of earnings.

Meanwhile, the actor Nicholas Cage is spectacular proof of the old adage that it’s not what you earn, but what you keep, that counts. Having coined more than $94 million in his acting roles, Cage has blown it all -  on a dozen houses, two castles, two islands, one dinosaur skull, one million dollars worth of comic books, two shrunken human heads, eighteen motorbikes, at least thirty cars, two yachts. And a jet. Now he’s broke AND the taxman’s after him for $6 million.

He used to drive a Ferrari Enzo...

In the book, The Millionaire Next Door, Thomas Stanley and William Danko show that self-made millionaires share particular traits. They are financially well-disciplined: they spend a lot less than they earn, consistently invest their savings, and don’t try to score speculative home runs with their investments. And they don’t live particularly flash lifestyles, because self-made millionaires are really clear on the difference between consumption and saving. This is where Nicholas Cage went horribly wrong.

The CapGem analysis proves that financial discipline and intelligent investing can quite feasibly get you to millionaire status off far less than movie star earnings. In fact, if you invest a monthly average of USD1,202 at a steady 5% return from the age of 30, you’ll have a million dollars by the time you’re 60. And with a steady long term 10% return, you’d need to invest only $442 a month.

So, the good news is you don’t have to down tools and head for Hollywood in search of your fortune. Time, discipline and a constructive investment strategy can grow your perfectly normal monthly savings to a million dollars during your working life, without the need for wildly speculative investment gambles.

Ten million level-headed people have built up  a million dollars. You can too.

In fact, the concept of an official retirement age came to life in 1889, when Germany’s ‘Iron Chancellor’ Bismarck declared 65 years as the age that Germany would begin paying workers a state pension. Bismarck’s motives were as much political as altruistic. While his flash of inspiration won over the German working class (and quashed the rival Socialist Party) Bismarck also knew that after a life of back-breaking hard labour, the average German worker never reached 65. And of those who did, most didn’t live much longer. The shrewd Iron Chancellor knew the German state of 1889 could afford to meet the cost of those few pensions.

We live much longer now. Average life expectancy today is 82 years (and it’s longer for women). Yet in most countries the official retirement age is still stuck at 65; a number irrelevant to the realities of our medically advanced world of aging populations:

• More than 10 million people alive now in the UK will live past 100
• 40% of all Japanese will be older than 65 by 2055
• 17% of the European population will be over 100 years old in 2080
• The number of humans living to 100 has doubled every decade since 1950

And unlike Bismarck’s Germany, today’s developed nations are financially on their knees under the burden of soaring national debt: of every dollar of American public spending, 40c is borrowed. Indebted governments simply won’t be able to continue financing the state pensions of their aging populations – the maths just does not work. This message needs to get through.

French students protest the retirement age increasing from 60 to 62.

In Britain, for example, far too many people are still counting on a state pension:

• 430,000 fewer Britons set aside any retirement savings in 2010 than in 2009
• 25% of Britons older than 55 have no personal savings for retirement
• Ditto 47% of all working British women.

Americans are at least being more realistic. In a recent survey, only 5.3% of Americans still think the Government will provide their income in retirement.

Those of us living in non-welfare states in Asia and Africa have known from the get-go that a state-financed pension has never been on the cards. And nobody believes that mandatory retirement provisory schemes, such as Hong Kong’s MPF, will suffice (the highest required monthly contribution to the MPF is HKD 1,000, which is roughly the cost of dinner and wine for two on Hong Kong’s Hollywood Road).

So, forewarned is forearmed. You’re going to have to make sure you’ve earned, saved and invested enough to finance 15 – 20 years of living after you’ve stopped working. To put it another way, you’ll need to make sure that your savings across a thirty year working career are sufficient to cover twenty years of spending without working. That simply will not happen by saving cash, a fact you’ll know from a glance at the meagre interest accrued on your bank statement this month. Across the world, everybody’s beginning to feel the pinch of real inflation for the first time in decades.You have to – intelligently and constructively – focus on investing for solid, ongoing long term growth on your savings.

This is not an enjoyable topic to write about, and it’s a tough message to read. But it’s also not the kind of thing you want to find out about twenty years too late.