The Memory Trap: Why Your Brain is the Most Dangerous Asset in Your Portfolio
The Glitch in Your Financial OS
Right now, your brain is actively rewriting your financial history. It isn't maliciously lying to you; it’s doing something far more subtle and dangerous: it is editing your memories to match the mood of the current market.
If the market is up today, you are chemically primed to remember your past trades as brilliant successes. If the market is down, you recall a history of painful losses. This isn't just a feeling—it is a measurable cognitive failure that drives irrational investment decisions.
New research from the Quarterly Journal of Economics (November 2025) has exposed this "memory-based belief" system. By comparing what investors thought happened against what actually happened, researchers uncovered a stark reality: You don't trade based on facts. You trade based on a fiction your memory just invented.
The Audit: 17,000 Investors vs. The Truth
To prove this, a research team led by Cameron Peng (LSE) and colleagues didn't just ask people how they felt. They conducted a forensic audit of investor memory.
Between 2021 and 2022, they surveyed 17,324 retail investors across 30 provinces in China. Crucially, for over 5,000 of these respondents, the researchers obtained complete, transaction-level trading records. They could compare the investor's "Probed Recall" (what they claimed they earned) against the hard data of their brokerage accounts.
The disconnect was alarming.
- Daily Recall: Correlation with reality was a dismal r = 0.10.
- Monthly Recall: Rose slightly to r = 0.25.
- Yearly Recall: Peaked at only r = 0.32.
The Takeaway: In the short term, your memory of your financial performance is effectively random. Even over a year, it is barely better than a guess.
The Mechanism: Similarity-Based Recall
Why is our memory so flawed? The researchers identified a mechanism called "Similarity-Based Recall."
Your brain uses the present as a search query for the past. When today's market returns are high, your brain retrieves memories of other times when returns were high. The data reveals the magnitude of this distortion:
- The Multiplier Effect: A 1 percentage point (pp) increase in today’s market return triggers a 2.5–4.1 pp increase in recalled returns from past market episodes.
- The Personal Distortion: For your own portfolio, a 1 pp increase in today's return inflates your memory of last month's performance by 1.04 pp.
This creates a dangerous feedback loop. If the market is up, you recall winning. Because you recall winning, you become overconfident. The study found that investors who selectively recalled positive experiences increased their expected returns for the next year by 1.8 percentage points—and subsequently bought more equities, often right at the peak.
Memory Beats Reality
Perhaps the most humbling finding for data-driven investors is that your delusions are stronger than your data.
When researchers ran "horse race" regressions to see what actually predicts an investor's future expectations, memory won.
- Recalled Returns explained 8.0% of the variation in return expectations.
- Demographics (Age, Wealth, Education, Experience) explained only 4.7%.
Actual historical returns—the objective truth—lost statistical significance when pitted against memory. In the battle for your belief system, what you think happened matters more than what actually occurred.
Beyond the Market: The Budgeting Blind Spot
This cognitive distortion isn't limited to stock tickers; it infects your personal banking, too. The same "similarity" bias suggests that checking your bank account on a payday triggers memories of financial comfort, potentially masking memories of previous overspending.
- The Positivity Bias: Research indicates that after just one week, people remember 23% more positive financial outcomes and 10% fewer negative ones.
- The Tracking Gap: While 96% of Americans have a budget, only 12% compare their actual spending to that budget daily.
This creates a self-reinforcing cycle of poor record-keeping. We avoid documenting our finances because our brains are actively suppressing the painful memories of bad spending, leaving us with a "highlight reel" that justifies further consumption.
The Architect of the Study
This research is the latest from Cameron Peng, an Assistant Professor of Finance at the London School of Economics and a rising star in behavioral finance. A Yale PhD and founder of the London Behavioral Finance Group, Peng’s work focuses on "Taming the Bias Zoo"—identifying which of the hundreds of psychological biases actually move markets. This paper, which won the 2023 CFRC Behavioral Finance Best Paper Award, fundamentally challenges the "Full Information Rational Expectations" (FIRE) model that underpins traditional economic theory.
CTA: Inoculate Your Portfolio Against Your Brain
The market is volatile; your memory shouldn't be. The research is clear: you cannot "think" your way to an accurate assessment of your performance because your thinking is compromised by the very market you are analyzing.
Your Action Plan:
- Stop "Ballparking" It: Never rely on intuition to gauge performance. If you feel like you "usually beat the market," you are likely experiencing a similarity-based hallucination.
- Automate Reality: Use tools that aggregate and visualize your actual returns (time-weighted and money-weighted) alongside a benchmark.
- The Journal Defense: Write down your thesis before you place a trade. Create a contemporaneous record of why you are buying. When you review the trade in six months, read your notes, not your mind.
Memory Point: Your financial autobiography is being continuously rewritten by the market. To protect your wealth, stop trusting your recall and start trusting your records.
Building those records doesn't require complex software or expensive advisors. Plain-text accounting systems like Beancount create immutable, version-controlled financial histories—the kind of contemporaneous documentation that protects you from your brain's editing process. When your ledger is stored as code, your memory can't rewrite the past.
