Recently, I saw some interesting information about how our brain functions. The brain has 3 parts: The Hominid Brain which is responsible for higher thought and reasoning, the Mammalian Brain which is responsible for feelings like love, hate, lust, fear, anger, and hurt. This part is also in charge or our “fight or flight” response, and finally the Reptilian Brain, which takes care of our basic survival functions like breathing, heartbeat, etc. Understanding which part of your brain is doing the thinking can be a big help when making decisions about your portfolio and financial future.1
Most of us assume that all three parts of our brain are always working together. To the contrary, studies have shown that sometimes the different parts of our brain are not all functioning in harmony. During times of extreme stress, such as the financial crisis in 2008 and 2009, the logical, reasoning part of our brain (Hominid) actually shuts down completely. Our brain goes into survival mode and all of the blood flows to the parts that keep us alive (Reptilian and Mammalian).1 Unable to look at things logically, we become irrational and emotion takes over. Sadly this leads investors to the destructive habit of selling at market bottoms and buying at market tops.
Neuroeconomics is a relatively new discipline that combines psychology, neuroscience and economics to better understand how we make financial decisions. A book by Jason Zweig entitled “Your Money & Your Brain” offers some fascinating findings:
- A monetary loss or gain is not just a financial or psychological outcome, but a biological change that has profound physical affects on the brain and body.
- The neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine.
- After two repetitions of a stimulus – like the markets having two big up days in a row – the brain automatically, unconsciously, and uncontrollably expects a third repetition.
- Once people conclude that an investment’s returns are “predictable,” their brains respond with alarm if that apparent pattern is broken.
- Financial losses are processed in the same areas of the brain that respond to mortal danger.
- Anticipating a gain, and actually receiving it, are expressed in entirely different ways in the brain.
- Expecting both good and bad events is often more intense than experiencing them.
The bottom line to his book is that many of us repeat poor decision making in regard to investments because we do not recognize and understand our own detrimental behavior. To quote Zweig, “…our investing brains often drive us to do things that make no logical sense – but make perfect emotional sense. That does not make us irrational, it makes us human.” Understanding why we do what we do is a good first step to becoming a successful investor.
1. Fighting against physiology, John Hancock Funds, 5-2010
Damien helps individuals invest and manage risk. He is a CERTIFIED FINANCIAL PLANNER™ professional and a principal of Walnut Creek Wealth Management. These are the views of Damien Couture, CFP® and should not be construed as investment advice. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or Damien@WalnutCreekWealth.com.
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