Your Brain is the Worst Investor in the Room — ft. Scott Nations

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1:12welcome to prof g markets scott is still away he will be back on monday but we have a great interview today we have been spending a lot of time this year thinking about how to invest in 2026. We've been hearing the bull case. We've heard the bear case. Still, it is hard to know what to think. So today we are talking to someone who spent his whole career studying this stuff. He's also written a book on how to invest in uncertain times. He's also written another book about US market crashes. So we're very excited to speak with him. We're going to get into it now. This is our conversation with Scott Nations, president of Nations Indexes and author of the Anxious Investor.

1:57Scott, thank you very much for joining me on Prof G Markets. Thanks for having me. So, a lot we want to get into here. I want to start with some concepts from your book, and then I want to sort of think about how we can apply these ideas to markets and how we can think about investing in 2026. But let's just start with your book. The opening line from The Anxious investor is, quote, the human brain is ill-suited for making wise investment decisions. I love that. Why is the human brain so bad at making investment decisions? The simple explanation is that investing is relatively new and evolution is not.

2:44And so human beings evolved when they faced very different decisions versus, you know, what should I do with my portfolio or that sort of thing? And let's face it, that for 100 ,000 years, when humans were on the savanna, they had to become loss averse or risk averse, two different things, but they're related. because the cost of making the right decision or the benefit for making the right decision would be relatively small. You might get that night's meal. But the cost of making a wrong decision could be catastrophic. And so we've evolved and we've been socialized in ways that just are not really compatible with making great investment decisions.

3:33And as I was writing the book and researching the behavioral biases that we all display, it dawned on me that of the 14 or 15 I talk about in the book, none of them, not a single one, Ed, makes you a better investor. They all make you a poorer investor. They all hurt investment returns. And so that's why that is the case, because these biases were created hundreds of thousands of years ago in some cases. But unfortunately, investing is relatively new. The piece of data that you point out, and this is from Vanguard, which I find fascinating, is that behavioral biases, these biases that you talk about, on average, they reduce returns by 150 basis points per year.

4:24So that's minus one and a half percent because of whatever these evolutionary behavioral biases built into the human brain are. um what are some of these biases you mentioned loss aversion risk aversion what are some of the the really bad ones that screw investors up the most there are a couple that are just particularly fascinating to me now i spent 25 years as a proprietary option trader at the chicago mercantile exchange so trading for my own account trading for my firm's proprietary account and so i've seen all of these biases in action. I will say this. One of the ones that, as a proprietary trader, you have to really disabuse yourself of straight away is the disposition effect.

5:12And it's one of the most insidious, but also common biases. Let's define our terms. The disposition effect is the tendency that all investors have to sell their winners and hold their losers. And there is some research which quantifies the loss that most investors experience by falling for this, that is by selling their winners and holding their losers. And the reason I say it's insidious is because it's so easy to rationalize what you're doing. You're looking at your portfolio, you want to sell something to raise some money. And so you say, well, this one's done really well, so I'm going to sell it and I'm not being greedy.

5:57Pat myself on the back, I'm not going to be greedy. So I'm going to go ahead and take my big win there. On the other hand, you may be looking for something and you say, you know what? This one's a loser. It hasn't done very well. But again, pat myself on the back. I'm going to be patient. I'm going to be patient. And so I'm going to hold on to my loser. But Professor Terry O'Dean at Cal Berkeley is the one who's quantified the damage does to your portfolio. And he shows that over time, the winners that you sell will outperform the losers that you hold. What about if it could happen the other way where maybe, I mean, I don't know if this is a bias that affects investors as much as perhaps the disposition effect.

6:37But, you know, oh, the line's going up, therefore it must be continuing to go up forever, as an example. Or the line's going down and so, oh, no, that's a bad thing. That's a red flag. Is that another bias that we see in the markets or is that less of a problem? That is certainly the case. And there are several biases at work here. One is, say, availability. So if you hear about the fact that, for example, Google just became a$4 trillion company market cap wise. Well, that was in the news. So now if you're looking to buy something, Google will be top of mind for you. Whether or not it's, you know, had a really great run and you think, oh, it's top of mind, so I'm going to buy it.

7:20And so that is certainly the case. But there are other biases that kind of intersect here. One would be hurting. Investors love to buy what everybody else is buying. In the pit, you learn that that's absolutely the wrong way to go. But investors love to buy what other people are buying. So if they're piling into meme stocks like AMC or GameStop or Google or something else, it's done really well. Then they love to get into it. They love to follow the herd. There's a social aspect to it, particularly with meme stocks. And so those are all biases that will ultimately generate inferior returns. One of the biases that you talk about, which I find really interesting, is this idea of fantastic objects, that's fantastic spelled pH.

8:11And basically, this is this idea that people will buy stocks not necessarily because it's a good stock or because they've looked at the financials or whatever it is, but because they want to feel connected to the people who are behind that stock. So the example would be like in the 90s, you're buying Apple because you love Steve Jobs and you want to feel some sense of connection to Steve Jobs. Can you talk more about this one? I find this fascinating and always seeing this today. You've explained it perfectly. It is a situation where people, investors are enamored of some well-known founder or business executive.

8:53Often they're iconoclastic. They're often a little bit outside the box. They break the mold a little bit. In 1999, in that period, Steve Jobs, Bill Gates would have been the two perfect examples. and yeah, people buy either the product or the stock because they get this sense that in doing so, they're closer to physically, emotionally, socially closer to Steve Jobs or Bill Gates. And so they buy the product, they use the product or they buy the stock. And obviously, Bill Gates wants you to buy a Windows computer. He wants you to use Windows. He wants you to use a bunch of Microsoft software. but he doesn't know that you're doing that.

9:40He doesn't know that you own the stock. Not certain he particularly cares about that at this point, but people do fall for that. And the poster child right now would be Elon Musk. He's in the news. He's a conoclastic. He does things very differently, marches to the beat of his own drummer, whatever you want to say about him. But, you know, he builds a neat car and people feel like if they buy a Tesla, they're a little bit closer to him, in sympathy with him, And often they feel the same thing about the stock. If they buy Tesla stock, then, you know, maybe it's the Peter Lynch thing from so many decades ago.

10:17You know, it's what I'm buying, what I know. Well, you don't really know, but you like the story and that's fine. And so you buy the stock. One thing that's so difficult about markets and about investing, I mean, those people who are buying Tesla stock because they like the story, because they like Elon Musk, they want to feel close to him. which I think is definitely true. And I think it is a problem, but they've been rewarded at the same time. They've done pretty well. If you were a big fan of Elon Musk, and then it turns out a lot of people are a big fan of Elon Musk, even if that is the primary force driving the valuation of the company.

10:54I'll get hate for saying that, but imagine it is, you're still being rewarded. And I guess this is the thing that I struggle with markets is it's all stories in a lot of ways. I Stories are what drive markets. Stories are what drive valuation. I mean, there's obviously fundamentals too, but increasingly stories seem to be what determine price. And so it sounds like part of the idea of eliminating your biases is to eliminate your susceptibility to stories. But at the same time, that's the whole ballgame. So how do you think about these concepts? How do you think about the difference between, I guess, narrative versus numbers, which wins in which situations.

11:39How should I think about stories when I'm investing? Sure, it's easy for an investor to say, I don't, it doesn't matter why. Yeah, maybe I am falling for this and I buy Tesla stock because for all the wrong reasons that Scott's just enumerated, but it works. I'm not the only one. And if I'm not the only one, and the same could be true for, you know, GameStop during the meme phase. I can make a bunch of money. And isn't that where, isn't that really what matters? And that's absolutely true. And, you know, I remember being in the pit and there were times when you knew the pit was all one way and it didn't really matter what the next print was 60 seconds later.

12:29If you know which way the pit is leaning, then that's half the battle. And so it's easy to say, well, you know, yeah, maybe it's crazy to buy Tesla stock because Elon is econoclastic. But if it works, it works. The problem is that it works until it doesn't. Yes. And then when it doesn't, we still hold on too long because we have confidence in the company or the founder. And we hold on, we hold on, we hold on. And we go through a series of stages, a little bit like the Kubler-Russ stages of grief. And it's only when we've gotten disgusted with ourselves that investors pull the plug, sell, and that's often at the bottom.

13:16So, you know, there's no way you can look at Tesla and explain away the premium that that stock brings, the multiple that that stock demands compared to the rest of the world automotive business. So, you know, if you want to buy it because you love Elon, then OK, go ahead. But I think you're setting yourself up for a dynamic that will not work out in the long run. Yeah, I mean, it seems as though because of these biases and because, you know, I think the example of, okay, Google's in the news a lot, I'm thinking about Google more, and now I'm inherently biased towards Google just because of this kind of arbitrary fact, which is I've been reading about it a lot.

14:01I keep on seeing the name. It makes me think that we can't quite trust our instincts, or maybe instincts is the wrong word, but we can't quite trust our brains all the time. We can't trust our view at any given moment. And that leaves us with the question of, okay, then what should we trust? And I guess I would put that forward to you as a highly experienced investor and also as a trader, someone who has been in the pit, who's been in this game for a long time. What do you trust then? If you can't quite trust yourself, or maybe there's a way to trust yourself, who are you supposed to trust if you can't rely on your own brain?

14:47I think one thing to do is to develop a process, tweak the process, and then when the process works, tweak it a little bit more, improve it, but start to rely on the process. And you hear professional athletes talking about this all the time. And so if your process is, oh, boy, Google just became a$4 trillion company. Let me buy 100 shares. Well, that process probably needs more than a little tweaking. Yes. But, you know, Warren Buffett probably put it most distinctly when he says that in the short term, the stock market's a voting machine. Lately, people have been voting for Google. They've been voting for Tesla.

15:24But in the long term, it's a weighing machine. That is its objective. If you were to ask somebody to name, say, the 20 companies in the S &P 500, there'd be tremendous overlap between the stocks that everybody names. And they're either the biggest stocks or the ones that have been in the news. But, you know, that leaves about 480 stocks that may be great investments that just don't get any attention, that people just ignore. And if you're going to limit your investment universe to a tiny fraction of things that are available, then doesn't it seem like you're going to underperform versus somebody who's looking at the entire universe of stocks?

16:11We'll be right back after the break. And if you're enjoying the show so far, send it to a friend. And please follow us if you haven't already.

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19:46We're back with Profity Markets. Just thinking about herd mentality for a moment, which you brought up as one of these biases. How do you counteract that bias? Yes. I struggle with this one because, you know, at the same time, you want to be informed by people. You want to have a broad understanding and a broad base of knowledge. You want to understand what's happening. So you want to be listening to other people. But at the same time, you don't want to be following other people just because that's what other people said. You don't want to just be the sheep in the herd. So as an investor and as a trader, how have you experienced that bias throughout your career?

20:33And are there any processes you employ to prevent falling susceptible to that? This goes hand in hand with another bias, and that is availability. So people tend to, and this is related to some of the other biases we've talked about already, If a potential investment is available to you, available to your mind, your memory, then you're going to tend to invest in that. And so you just have to ask yourself, I think you just have to have a fearless conversation with yourself. Why? Why is this top of mind for me right now? Is it because my next door neighbor or the guy across the street or somebody else mentioned it or I saw that it has rallied a bunch?

21:18Is that why it's available to me? Or is it available to me? Because I think, given the news, that oil field services companies are going to do well. And then I look at the top two or three or four oil field services providers. And that's a very different process. And so I think you have to, again, tweak your process, but also be honest with you. Why am I thinking about this now? Why am I doing this now? And if you can have that conversation with yourself, then I think you're going to end up being a better investor. I do think this is also applicable to life in general. It does seem as though we can't quite trust our emotions from any moment to another.

21:59And so the only real way to get anywhere is to have some process or maybe some list of values or some set of principles that you always return to. and then you can sort of figure out whether this is the right decision or the wrong one based on what you've already written and thought through on your own. So I do think it's great advice. I just want to think about how this all applies to the year 2026, where, I mean, we're going to see a lot of these forces at play. I'm going to just list a few of the forces that I think are going to be big this year. and which happened to be subjects on which you are an expert.

22:45So one is extreme volatility. This is something we saw in 2025. We had Liberation Day, among other things. That is likely to continue. Two, a potential bubble. This has been a big topic of conversation that we've been debating with various people in this podcast over the past six months or so. Three, an explosion in options trading. specifically zero-day options trading, which we can get into. Also an explosion in retail trading and what that might do to markets. And then finally, I would add into this the arrival of prediction markets, which kind of became sort of a big deal, but now they appear to be a really big deal.

23:30There are more, but I mentioned these ones because you're an expert in all of them. You run a volatility index firm. You're an options trader. You've written about bubbles. You've written about crashes. Which forces are the most significant in your mind right now? And how do you see it playing out in 2026? The one that's going to be most important to most people is the second thing you mentioned, and that's the AI investment thesis. I don't know if it's a bubble yet, but let's try and run down and I'll be real quick with each one. So extraordinary volatility. We saw that in April surrounding Trump tariffs.

24:10Market's been very quiet the last, was very quiet the last half of 2025. We know it doesn't stay that way. Volatility, and when I talk about volatility, I generally mean both. Implied volatility, that is the cost of options, how risky option traders think the next 30 or 60 days are going to be, and then realize volatility, how much the market actually bounces around. So hasn't bounced around very much. It's done really well, more or less straight up. S &P gained about 17 % last year. So this is one of those things that it will stay quiet until all of a sudden it doesn't. And there's a really geeky word about volatility.

24:52Volatility is heteroscedastic, meaning it'll stay low for a while and then some shock will come along and it will jump and it will stay high for a while. The shock and the jump is going to happen. Uh, tomorrow, don't know. Next month, is it next year? We don't know. Uh, but people have to be, uh, have to have a portfolio that can weather that sort of thing that's not overly, uh, not overly aggressive. I'm interested to hear why we've seen this transition in volatility over the past year. I mean, we had a very volatile first half of the year, primarily due to the tariffs. And then gradually, as you say, it becomes less volatile.

25:36And actually what we're experiencing now are some pretty big geopolitical events, political events that you would think would royal investors, would spark some activity in the markets, by some volatility. But in many cases, that isn't happening. And one thing that we've been discussing this week, for example, this criminal investigation to Jerome Powell, which had a reaction from markets, but less of a reaction than one might expect in previous years, for example. As a volatility expert, I just want to get your views on why this is happening. Is it maybe the talk of vacation of markets? Why is it that we're seeing less volatility today?

26:22Well, and I think another perfect example is the incursion into Venezuela. Yes. When I read about that, it was on a Saturday morning, I thought, oh boy, I got to watch the futures markets open on Sunday night. And the lack of volatility was really staggering. It really was. Why is that happening now? Well, I think people have just gotten inured to the fact that even if markets sell off, dip buyers will come in. And among some of the people who just blindly come in to buy stocks when they're down, it's buy the effing dip. And that's worked. It's worked for years. It worked after COVID. It worked this April.

27:07And so I think people, they're just fearless. They're fearless now. And we have to, unfortunately, we have to learn these lessons all over again. we will have some sort of ugly debacle, and stocks will probably fall 20 % to 25 % from their highs. And it's only then that people will learn the lesson, oh, yeah, you know, this does happen. You know, markets don't go straight up. I shouldn't always buy the dip just because I can buy the dip. It's interesting because on the one hand, people seem to get very worried when there's a lot of volatility. I mean, the VIX, it's literally people call it the volatility index, the fear index.