John Heinzl

Published on Sunday, Apr. 11, 2010 6:51PM EDTLast updated on Monday, Apr. 12, 2010 7:50AM EDT

William Bernstein's latest book, The Investor's Manifesto , has the usual complement of tables, graphs and return calculations you'd expect in an investing manual. It also has something you don't normally see: a diagram of the human brain.

A retired neurologist, the 61-year-old author and money manager is as comfortable discussing the efficient market hypothesis as he is explaining the functions of the cerebral cortex and hippocampus. That gives him a unique – and sobering – perspective on the massive run-up in stock prices in the past year.

As Mr. Bernstein explains it, the key to understanding why investors are merrily embracing risk again lies in two tiny bundles of neurons called the nuclei accumbens . Situated just behind each eye, they serve as the brain's “anticipation centre.” If you've ever wondered where greed lives, it's here.

“This lights up whenever we anticipate something good happening. And that something good could be food, it could be social contact, it could be sex, or it could be making a lot of money in the market,” he said from his home in Portland, Ore.

Here's the problem: After a 76-per-cent advance in the S&P 500 since the market bottomed in March, 2009, investors' nuclei accumbens are lighting up like Christmas trees. And in this heightened state of anticipation investors are much more willing to take on risk by loading up on stocks.

And that's a big mistake, he said.

“The worst thing people could be doing is getting back into the market after prices have doubled,” he said. “The primary mistake most small investors make is they confuse the economic outlook with returns going forward. In fact, the best forward-looking returns are obtained when the economy looks the worst, and the worst returns are obtained when the economy looks the best.”