Your Irrational Brain CAN Hurt You
Posted by Gail | Filed under Psychology
Behavioural psychology is one of those fields where every day brings new and interesting discoveries. Out of Behavioural psychology grew behavioural finance; that’s a field dedicated to understanding why we’re so delusional about our money. Imagine! We are so screwed up when it comes to how we make decisions about what to do with our money that it’s spawned an entire field of research. Wow!
For years investment advisors wanted us to believe that most of the decisions we make are rational ones. It came as a big shock when they discovered that investors aren’t rational. Yup, we can be pretty stupid sometimes.
Did you know that in 2001 a research firm released a study that showed average investors got only a 5.32% return over seven years leading up to the end of 2000, while the Standard & Poores 500 index returned an average of 16.29% per year. Damn, that’s a lot of misguided investing.
Economist Burton Malkiel wrote, “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.”
Maybe. A Russian chimp out-performed 94% of the country’s investment funds with her portfolio growing by three times in 2010. Lusha, a circus chimpanzee, outperformed almost all of Russia’s investment funds with her stock picks. Makes you say, “Huh?” doesn’t it when you think of all the brouhaha over investment management teams and the fees they charge. You might just think this a funny story except for the fact that Pavel Trunin, the head of monetary policy department at the Institute for the Economy in Transition in Moscow, said, ‘It shows that financial knowledge does not play a great role in giving forecasts to how the market will change. It is usually a matter of more or less successful guessing. And the monkey got lucky.’ Damn! And damn again!
Lest you think our irrationality only manifest when we’re trying to make money, along comes a study from Stanford University. People’s brains were scanned as they looked at desirable goods and their prices, and the most active brain areas were recorded. The result: while distinct parts of the brain anticipate having the item, others register the impact of having to part with money.
The nucleus accumbens, which is our pleasure centre because it is full of dopamine receptors, lights up when we want something. That’s the ignition of the fire of want. Our insula, which is associated with pain, is activated by prices that seem too high. So it’s like the sprinkler system putting out the fire. There is, it turns out, an actual physicality to the trade-off between really wanting something, and having to pay for it.
However, if you thwart your insula by bypassing it, the sprinkler won’t come on and your nucleus accumbens will run rampant.
Credit cards are like an anesthetic on your insula since you don’t feel the pain of actually having to part with cash. When you swipe, your insula won’t douse the heat of acquisition. And if the retailer or salesperson can convince you you’re getting a deal, your insula won’t rain on your parade and stop you from spending.
Want a way around that problem? Try using a spending journal. If each time you swipe you deduct what you’re spending from your bank balance, you’ll give the insula something to work with.