Your Irrational Brain CAN Hurt You

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.

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Gail Vaz-Oxlade

Gail Vaz-Oxlade wants YOU! Join MyMoneyMyChoices.com to get smarter about your money and help others get smarter about theirs. Isn’t it time we eliminated financial illiteracy? Come find me on Google+ and on Twitter.

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16 Responses to “Your Irrational Brain CAN Hurt You”

  1. So……is the Russian chimp accepting new clients?

  2. Think of the CC as a debit card, that might help.

  3. I have the sudden urge to go buy a pet monkey. : – ) I wish I could say that I’m just super smart when it comes to money, but I must admit that part of my financial success comes from an over active insula, and no the credit card anesthetic doesn’t work.

  4. You know I must be a weird wired brain. I find if I have cash money in my pocket, I want to spend it so bad. But I hate putting things on credit card, because I know that sooner or later that big bill is gonna come punch me in the face. Luckily I don’t carry much cash with me!

  5. My brain works the same way as Geoff’s- if I have cash in my wallet I am more likely to spend it faster than if I were to charge something on a credit card or use debit.

    I keep a tally in my mind of how much money is in my bank account and every time I use my debit card I calculate the new total.

    Ditto with the CC. I add up all my purchases then in my mind subtract it from the amount I have in my bank account. I guess I don’t have a physical spending journal, but I have a good memory and I check my online banking daily.

    In my mind, cash is already subtracted from my account, so it feels like “free” money and it disappears way faster! I guess it’s a little backwards.

  6. I would rather have $5 dollars in the bank to last me a a week than owe anyone anything. My brain has always prioritized making debt repayment before anything else. It worked against me for a while, and I had to give myself permission to pay some of the things off a bit more slowly to keep cash flow accurate.

    That was years ago (pre-Gail!) and now my credit cards, debit cards and cash flow work well together within the allowance I give myself for purchases. I took Gail’s kid advice and give myself $42 a week (I’m 42)!

  7. Beyond gas and groceries there really isn’t much spent at our place. The spending we do is ALWAYS done on the credit card for Aeroplan miles. If something does NEED to be bought that wasn’t planned for on the spreadsheet already, when I get home I add a row for the item, add the amount and deduct it off the remaining balance. When I purchase the planned groceries or gas, I udpate that night and replace the budgetted number with the actual number. A tank of gas fluctuates a little based on the price du jour, but with planning the groceries come in within $2 of the planned amount every week. Every Friday I pay off all the credit card items. I think of it a a slow motion debit card. Instead of the money going out of my account while I’m standing in the store, it comes out on Friday. If the money isn’t in the account I don’t swipe.
    Cash is another story. Somehow since the purchases can remain anonymous and don’t get itemized on the spreadsheet, I’m a little more relaxed. At the moment I have $1.39 in my wallet and no plans to get any more. I like that it’s not enough to get anything from the vending machine at work, but enough to make a couple of payphone calls if my cellphone died.

  8. Karen, that’s cute about the $42 per week based on age.
    I’m always curious about those who budget to give themselves an allowance. What do you spend it on? I’m serious. We tried it and gave up, but I’m still interested in what others do with the money or why they budget that way.

    We used to allocate $60/wk as miscellanous for the both of us. We’d each take $30 and at first I know I personally found ways to spend it. Eventually though I realized most of what it was spent on was total crap that really held no value to me. I think I was feeling obligated to spend it because I’d already approved myself to do so, and it was in the budget. Kind of dumb. So eventually we just stopped taking out that pocket money every week because it was collecting dust in both our wallets. Now we allocate $0 and if someone wants a coffee once or twice a month, they get it. Allocating and tracking fun money each week when neither of us spent it turned out to be a make work project. Most weeks nothing beyond the items on the spending plan are purchased so all the excess in the account gets moved to either our retirement accounts or we make an extra mortgage payment. I feel much better having that pocket money going toward those things which I do appreciate.

    Maybe if we had pricey hobbies, or liked to eat out at work, or I was a “girlie girl” with an appetite for pedicures or expensive haircuts I’d use the allowance to curb my spending on things that are clearly wants and not needs. Years ago I had a little problem with spending on decorating magazines, but I eventually nipped that addiction and instead I check out online sites for my fix of beautiful rooms. Looking is free and I’ve become quite content to just look (and mentally change things they’ve done). If looking was leading to constant redecorating I’d have to give up that habbit too!

  9. great post gail!

  10. […] Gail Vaz Oxlade- Your Irrational Brain Can Hurt You […]

  11. We allot ourselves a little spending money, at the moment it is $3.75 each a week but now I have had a salary increase it is going up to $7.50. This means that we can have a coffee out if we want, I can buy some spinning fibre or knitting yarn and my husband can pickup a great something from the thrift store. Before we had a budget, I would short change myself to try to make things work. Now I don’t have to do that, in fact, I feel rich with my spending money in my pocket.

  12. We aren’t as “spend friendly”as we used to be with cash in our wallets but if it’s there we’re apt to spend it faster than if we use our credit cards. Now, we haven’t paid a lick of interest on our credit cards and use them for the rewards and convenience (heck did I just say, convenience) that’s right and as long as we don’t pay interest and they (CC) pays me back $$$ we’re in business. Until then, cash can stay out of my wallet except for the odd $5- or $10 …. Great post Gail

  13. @ Blaze – I actually use it the way I use my son’s allowance:) I pay for clothes, haircuts, a magazine or lunch with a friend – those little extras that are “nice to haves”, but not need to haves. It works for me because the rest of the budget balances and it gives me a margin of pleasures. I do find it hard to see the $168 as a line item in the budget, though:D

    I totally hear you on the magazines. Mine are food magazines, but I have two subscriptions that I just love. Both were gifts!

  14. Hi, Blaze. My allowance is anything leftover after all automatic deductions go through. I have auto-debits set up for my emergency fund, my charitable donations, my early retirement fund, my short-term goals, my nice-to-haves, property taxes, insurance, house renovations and my monthly utilities. Anything leftover is my allowance. I spend it on the variable expenses of life: gas, food, entertainment, travel, clothes, pampering, hobbies, lunches, coffees, lottery tickets, etc…

    Like another poster above, I use my credit cards to work my way towards free groceries. I check my bank accounts and credit card balances on a daily basis. As soon as the transaction has been posted, I make a payment against my credit card from my bank account. (If the payment for the credit charge is paid before the transaction is posted, then I don’t earn any points towards my free groceries.) More often that not, my credit card statement is 1-2 pages long but indicates that my balance owing is $0.

    Sorry, Gail – I don’t write anything down. When my wallet is empty, I simply stop spending my cash! :)

  15. Institutionalized gambling. That’s what the world rely on now and the dealer is laughing at you because the bank never loses. At best, to take a roulette imagery, every single one of them advises to spread portions of your money on several numbers, statistically, one has to come up once here and there to offset the loss on the others.

    All of it marketed in a spirit of endless growth… Gotta love the Chimps for he has no care for our monkey business.

  16. I wrote things down on the go for a while, and it was a great way to keep me thinking! But the downside is that I’m very good at making excuses. “Oh, I don’t have a working pen. I’ll get to it later,” became a favorite. Cash works well for me. We put groceries and gas on the CC for the points, bills come straight out of the account, but all the little every day categories we use your jar system (except it’s in envelopes) and write it down when we get home.

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