Beyond the Money

Home » Behavioral Finance » How Are Decisions Really Made?

How Are Decisions Really Made?

Enter your email address to follow this blog and receive notifications of new posts by email.

Twitter Updates

Error: Twitter did not respond. Please wait a few minutes and refresh this page.

The brain scan on the left side of the image below was taken just before an individual placed a stock trade. The right side is a scan of a brain just before being given a hit of cocaine.

Brains_Scans_-_Finance_v_Drugs

The most troubling thing about these images is that activity is limited to the exact same part of the brain in either event. In fact, the images are virtually indistinguishable.

Contrary to common belief, our decisions are actually made with our “right brains” – part of our brains that is commonly referred to as emotional, subjective and intuitive. This statement is particularly controversial because we generally believe that we are rational people and make most of our decisions after an objective evaluation – in our “left brains.” In reality, we actually make most of our decisions before we are consciously aware that we have made them!

With respect to our financial lives, this is even more controversial because as soon as we hear the word finance, our “left brain” springs into action. We have conditioned ourselves to believe that finance and mathematics are inextricably linked, and therefore, we believe we make financial decisions based on a linear thought process. However, the process of financial decision-making actually begins with a decision (or hypothesis, gut feeling, market forecast, etc.) followed by an attempt to rationalize it. We must not confuse this with rational thought.

What we are talking about here is simply biology, and we can’t change the way our minds work. A simple example of this can be found in the scans above. The rational part of our brain tells us the two scenarios outlined are very different, but our emotional brain can’t tell the difference. The “left brain” tells us that drugs are bad, and making money is good. The “right brain” simply recognizes that we are about to benefit from something.

Since we can’t change how we are wired, we must focus on designing our environment and framework for decision-making. Through rational thought, we have the ability to control our urges by recognizing the inherent danger in certain situations. For example, we can readily acknowledge the danger in using cocaine. However, we often neglect to acknowledge that danger when it applies to money (or we greatly underweight it) because it does not cause us direct physical harm. Just as cocaine can permanently impair our physical lives, choosing to ignore the emotional draw toward financial decisions can permanently impair our financial lives.

As we sit here today, all of this sounds so obvious and easy to combat. However, when the sheer volume of information that we are forced to process in a given moment is combined with the busyness and distractions of our day-to-day lives, it is nearly impossible to make the best decision every time.

In the game of life, perfection is merely an idea. We can’t change how we are biologically wired, but we can redesign our thought process and reorganize our environment toward a framework that will help us make consistently better decisions. To do so, however, we must begin by acknowledging why, how and where our decisions are actually made.

Like the eventual deterioration of our bodies as a result of cocaine, the pursuit of short-term financial gain can set us up for long-term financial ruin. In the former, we insulate ourselves from the dangers of drugs through avoidance after internalizing the reality that using cocaine is bad. It would provide a great deal of benefit to construct a similar framework and mindset for our financial decision-making process as well.

Advertisements

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: