By Erin Eddins Financial Well-Being
When making financial decisions, you naturally employ rational, conscious thinking, right?
Are you sure?
New tools like PET scans and functional magnetic resonance imaging have given neuroscientists an unprecedented view of the brain.
And now their research is prompting psychologists to consider the effects of brain function, emotion and stress on decision-making.
Let’s consider how examining your thinking can help you make better financial choices.
Remember the popular theory about the creative right half of the brain and the logical left half?
Turns out, your brain is probably not divided along those lines.
Current research suggests that you actually have two thought systems: a fast, instinctive and emotional thought system that’s quite powerful, and a slower, more deliberative and logical one that tires easily. When the emotional brain jumps to conclusions or takes shortcuts, the more rational brain often doesn’t question them.
Because of these two systems, it can be hard to make financial decisions without your emotional brain taking over, even when you’re confident that you’ve set emotions aside. Money raises emotional complexities rooted in your upbringing, self-esteem, and hopes and fears about the future. A financial decision might be triggered by an abrupt dip in the market, a hot tip from an admired friend or a buried childhood anxiety, with the emotional brain favoring short-term reaction over long-term reflection. In fact, brain research shows that your conscious mind — your thoughts and memories — are involved in only 1 to 9 percent of every decision, and the rest is unconscious.
This isn’t to say that unconscious emotional choices are necessarily bad ones. Many students of brain science believe it’s undesirable or even impossible to eliminate emotion from the decision-making process. They see emotion as the partner of reason, rather than the enemy, because the brain is designed to work as a whole, with integrated analytic and emotional capacities. Instead of swinging too far in either direction, a wise approach is to take a middle path that actively engages both head and heart.
The key is to be aware of both brain responses. With a better understanding of how the brain works, consider your state of mind before making financial decisions.
For example, by consciously examining emotional biases that spring from past experiences, you can rid them of their power before they distort your judgment, while still drawing useful lessons from them.
Even when the rational and emotional brains are integrated, decisions can be derailed by stress. Anxiety and fatigue disrupt the prefrontal cortex, sending you into a primitive survival mode that employs the same neural and hormonal systems that spurred our ancestors to escape from charging lions. But since most episodes of stress in the wild ended quickly, our bodies are designed to manage brief bursts of stress followed by long stretches of relaxed recovery. The trouble is that today we experience continuous mild to moderate stress without those periods of relief. Explore stress management techniques to address this dilemma, and avoid major financial decisions when you’re exhausted at the end of a busy week.
Now that you know your financial thinking isn’t always as rational as you assumed, what can you do to improve your decisions? First, try to mull over financial questions at a time when you’re mentally rested. Second, focus on a long-term plan rather than daunting short-term risks or alluring short-term rewards. And third, discuss important decisions with someone you trust — someone who can bring perspective to both your logical thoughts and your emotional responses to money.
Erin Eddins is a chartered financial consultant, a member of the Financial Planning Association and is a certified financial planner with StanCorp Investment Advisers Inc. She can be reached at firstname.lastname@example.org or 425-212-5986.