Spare a moment. Pause, for just a while here and give this title a consideration? Initial reactions range from “no way “, to “I’m not sure”, to “this is outrageous!” “How can an organ, considered the most important in our anatomy, be labelled the stumbling block in achieving financial success? The converse is the reality, or so we assume. As part of my career in Financial Engineering, I have often been led into a sphere of intrigue that has caused me to consider the behavioural aspects influencing investment decisions, and it was not until a few years ago, when a leading Neuro Surgeon signed me up to help with his finances . As our paths intertwined, we forged a bond that was more than just a client–advisor–manager relationship, which endowed me the liberty to seek out neuro-logical solutions to the questions I had, and what follows is a summary of our learnings.
Most folks perceive investment as saving, and you will agree when I say these terms are used interchangeably, at will. This causes the embedment of the “risk averseness” in our brain. And this is where it all begins: Our brain, hardwired as it may be, is empowered to make split second decisions based on the information immediately available. Envision a tiger running toward us. Our survival instincts tell us to flee in order to stay alive. No advice is needed since our brain values “short term gain”. Likewise, our ability to make decisions is often impacted by our emotions and instincts. Unfortunately, these instincts are not always beneficial to us as investors, as we are better off considering long term trends and developing suitable strategies. Different parts of the brain have different roles to play and are responsible for different reactions. Attempting to understand how our brain functions during the decision making process make it easier to pause and listen to reason than be guided by emotion.
You have just received a hot, actionable, time bound, piece of financial insight furnished by a trusted acquaintance. How many of us would risk a year’s salary on this? I would like to believe that the greater majority would just prefer to stay away. What causes those who bite in on this insight react differently from those who prefer to not invest at all? Risk, gut reactions, lack of knowledge, never done it before…the reasons pro and contra are innumerable, and trust me, I’ve heard them all. The truth is our decision making process is complex and gaining a better understanding on why we behave the way we do will aid us in making smarter choices toward our financial success.
1. Your Brain’s battle zone – Prefrontal cortex:
- Imaging and studying the brain while evaluating a risky decision portrayed a battle being waged. A battle within your brain between two competing areas, attempting to process the possibility or lure of a big gain against the fear of risk. It is a classic battle, one that pits greed against fear, and in these battles, our emotions can get the better of us easily. The battle cannot be avoided, but can be controlled – setting investment rules on risk-reward ratios, seeking professional advice and sticking to this discipline in processing potential consequences. If we permit emotions to rule the roost, we would never invest. Train the brain to control the battle, not be driven by our emotion.
2. Fold or go for Gold – The Amygdala:
Feeling fearful in investing all of your yearly income into that one hot piece of financial insight that we hold? Well, that feeling of fear stems from here – the Amygdala. The fold or go for gold response can be an irresistible force in making investment decisions and fear can be a major stumbling block in our investment journey. Many of us would have never embarked on this journey owing to fear. Fear, can lead us into irrational decision making and cause us to do things we may regret later. Prior to setting out on the road to financial success, it is important to spell out our risk tolerance and be invested for the longer term. That benefits you with the time to let your investments grow and helps you sail by the fear inducing dips the investment could witness minus the added nervousness.
3. That great feeling –The Nuclei Accumbens:
Our studies revealed the obvious – Investors feel great when they have profited from a decision, and not so great otherwise. This feeling of “great” also spills over when investor decisions have helped their portfolio grow in value with time. The Nuclei Acumbens is your brain’s reward centre, churning out that feeling of “great” and a feeling of happiness. This area almost lights up when this happens, but then acting exclusively under its influence could be faulty. Apparently, it is important to derive and maintain that feeling of happiness with our investment decisions, and cause it to last, but with a level of risk that is tolerable. To achieve this, we learnt that preferring long term over short term and avoiding the temptation of trying to time the market helps.
3. The hare lost, but that’s the past – The Hippocampus:
Our memory mechanism can be broken down into short term and long term memories, and the Hippocampus plays a very critical role in forming our long-term memories. Our attempts to create new long term memories passes through the Hippocampus several times before it is fully formed and etched. Studying investors helped us to realize that negative memories from an investment experience many a time leads to investment paralysis. This is often the outcome of the result of the experience and not taking into account the factors or the data that caused it. It is therefore important for us to record and maintain a record of what worked in the past and what did not, just as we maintain records of our medical history, treatment plans, allergies etc. That way, the experience can be wired into data points or warnings which can be avoided while investing, thus diminishing the sourness of the past experience. In investing, it is important to look forward, to look ahead while learning from the past, not living in the past and staying frozen there. This helps us prepare for economic downturns, not letting one bad experience stall us on the road to success.
Making and taking decisions that impact our finances, our income streams, our financial future is one loaded with fear. There’s no denying that part. At the same time, there’s a lot going on in our brains each time we set out to make these investment decisions. It was enlightening to learn through these studies that fairly accurate advice from a trusted source can re-center your brain’s emotional bias to a more long term vision.
It’s a battle out there. Don’t let fear cause a tear in your eye. Feel great, for we’re here for the long haul. Don’t let your brain hamper your financial success.
