Our brains definitely impact our financial decisions.
In fact, our brains can help us make wise decisions or poor decisions. By using brain imaging equipment (specifically functional MRI), neuroscientists have been able to determine which parts of our brain are involved when we experience certain emotions or exhibit specific behaviors. There are two primary parts of the brain involved when we make financial decisions: the amygdala and the prefrontal cortex.
The amygdala lies within the limbic system, and is often called the reflexive brain, or reptilian or lizard brain. All mammals have an amygdala, and it plays a crucial role in our survival. The amygdala is a major center within the brain where our intuition, emotions, perception of risk or reward, and first impressions originate. Impulsive behavior originates in the amygdala, along with anger, fear and greed. It causes us to seek (and crave) rewards, such as sex, money, alcohol and drugs. It is often called the ancient brain.
The prefrontal cortex evolved more recently and is much larger in humans than in animals. The prefrontal cortex is where logic prevails, along with being able to consider the pros and cons of an idea. It lies directly behind our forehead and is often called the reflective brain.
Based on these descriptions, you can probably see that there may be conflict between the amygdala and the prefrontal cortex. Let’s assume the Dow Jones Industrial Average plummets 4,000 points tomorrow. How will you react? The amygdala will be sending out loud, impulsive signals, such as “danger, the sky is falling, you must sell all of your investments and run to cash!”
However, your prefrontal cortex should be saying “we know this happens occasionally, investing is never a smooth ride, it will recover, I have a long-term plan, my investments will be fine, and I will not overreact.” So, which behavior do you choose?
Neuroscientist and psychology professor Richard Davidson (of the University of Wisconsin-Madison) determined there are neurons that run within our brain from the prefrontal cortex to the amygdala, and these neurons can send calming signals to the amygdala. Perhaps you feel the fear arising from the amygdala, but your rational thoughts (from the prefrontal cortex) immediately overrule the impulsiveness of the amygdala. In order to be a wise investor, you want this calming effect to occur.
I encourage you to pay attention the next time the stock market plummets, and see if you can sense the signals originating from your amygdala and prefrontal cortex. Davidson found that some people have more of the calming neurons between the prefrontal cortex and the amygdala while other people have fewer.
Combating impulse
If you happen to be impulsive, what can you do? First, pay close attention and work to calm yourself down when you feel the amygdala being dominant in your brain. Fear and greed both originate in the amygdala, and both responses are the enemies of a good investor.
Having a long-term plan – and reviewing it often – can help. Setting up financial guardrails – such as waiting three days before making a major decision involving money, or getting a second opinion may also help. Conversely, if someone has a very dominant prefrontal cortex, they may feel the need for more data, and may tend to overanalyze a financial decision. The amygdala and prefrontal cortex can both be helpful for making wise financial decisions. You just need to keep them in check and not allow one or the other to be overly dominant.
Jason Zweig, personal finance columnist for the Wall Street Journal and author of “Your Money and Your Brain” believes wise investing includes rational thinking as well as emotions. He stated: “Pure rationality with no feelings can be as bad for your portfolio as sheer emotion unchecked by reason.”
Neuroplasticity
Another relevant area of research coming from the field of neuroscience involves neuroplasticity. Researchers have found that our brains are very malleable, and that our brains can build new neuron pathways at any time and any age. This happens simply from repeating a behavior.
An example is that you may feel you are “set in your ways” with a sedentary morning routine. But one morning you decide to take a 20-minute walk after breakfast, and you decide to repeat the walk four days a week for a month. This behavior is not only changing your brain, but it is also helping you establish a healthy new habit.
The key to neuroplasticity is repetition. Just as researchers have shown changes in the brains of people mastering a musical instrument, you can build new neuron pathways in your brain as you decide to eat more fruits and vegetables, write in a gratitude journal, and decide to give generously to others who are less fortunate.
During the COVID-19 crisis many people are suffering. If you are financially secure, please give to others. And think outside the box. If you typically give to a specific charity, consider gifting to neighbors or to people you encounter who are likely suffering financially.
You can do it without any fanfare. This may change your perspective and help you realize how incredibly fortunate you are. And, thanks to neuroplasticity, you will be building new neuron pathways.