Researchers from the fields of neuroscience, economics, and psychology — neuroeconomists — have been discovering the role that biology plays in financial decision-making and identifying why our brains can sometimes unwittingly stop us from making sound investment decisions.
Primal Emotions
Exploration into how the brain works and the emotional impact of investment decisions shows that if you’ve ever felt nervous when watching the price of an investment fall, you may have been receiving a message released by your amygdala, the part of your brain that initiates feelings of fear. The amygdala gives off adrenaline, which triggers our most primitive and protective response, preparing us for “fight or flight.” So while we typically no longer rely on our amygdala’s warning signals for our physical survival, it is still responsible for causing a sense of anxiety to arise when there is an expectation of a financial loss as well as when the market actually shifts.
Also, when faced with the prospect of achieving a positive outcome, certain neurons in the brain release dopamine, a neurotransmitter that regulates feelings of pleasure. The mere anticipation of making money on an investment could cause your brain to release this chemical — even more than when you truly realize the return on your assets.
Staying Centered
Neuroeconomists have found that the prefrontal cortex can help counter the amygdala’s impact and guide our thoughts and behavior as investors. The prefrontal cortex is the area of the brain responsible for evaluating the consequences of your actions: it is where people rationally weigh pros and cons. In effect, the prefrontal cortex can help you control impulsive messages sent from your amygdala by enabling you to concentrate, analyze concepts, and draw logical conclusions.
Smart Investing
To increase your chances of success as an investor, it may help to be aware of how primal emotions might influence the decisions we make and the actions we take regarding money. Understanding these instincts can enable your prefrontal cortex to form thoughtful judgments based on established investment strategies such as pursuing long-term goals and maintaining an appropriate asset allocation. As a result, we may be able to make more informed decisions—instead of allowing our primal emotions to guide our actions in a constantly changing market.
Source: Jason Zweig, Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, 2007.
[from T. Rowe Price Investor, March 2008]
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