This month I will be posting a series of articles that were published on the Albuquerque Journal. These articles will explore the relationship between money and happiness.
Are you ever disappointed after making what seems to be an emotional – and unwise – financial decision? Understanding how our brains are involved in our financial decisions may help.
Amygdala vs. prefrontal cortex
There are two primary parts of our brains involved in financial decisions. One part is called the amygdala. It is in the core of the brain and is sometimes called the reptilian brain. This is where strong emotions often originate, including fear, greed, anger and impulsivity (all enemies of a smart investor). If the stock market plummets 500 points tomorrow and you feel fear, this is arising from the amygdala.
The other part of the brain that is key to wise investing is the prefrontal cortex, which sits behind our foreheads. This is where logic and rational thinking occurs. The prefrontal cortex supports having a long-term financial plan that is focused on the future. It allows you to ponder the pros and cons of a decision.
The two parts of the brain can be in conflict when it comes to making wise financial decisions.
Neuroscientist and professor of psychology Richard Davidson uses brain imaging equipment (called Functional MRI) to study the brain. He and his colleagues at the University of Wisconsin, Madison, have determined that the left prefrontal cortex is involved in controlling a person’s emotional resilience. (He defines resilience as how slowly or quickly you recover from adversity.)
There are “axons” (white matter that connect one neuron to another) that run between the left prefrontal cortex and the amygdala that serve to “calm down” the amygdala. He has determined that some people have more axons than others. His research suggests that someone with a small number of axons may be impulsive when making financial decisions (e.g., they sell their investment assets when they become frightened by the stock market) because they have a dominant amygdala, and their prefrontal cortex is not providing enough support.
Conversely, people who have a dominant prefrontal cortex may feel that they must overanalyze a decision to the point where they cannot make a decision. The key is to be aware of both parts of your brain.
If you find yourself fearful the next time the stock market plummets, remind yourself that you have long-term goals and reacting impulsively is rarely wise. Tell yourself you will wait three days before making a major financial decision, and use that time to do research and get a second opinion. Give your prefrontal cortex time to calm down the amygdala so you can make a rational decision.
Neuroplasticity
Another concept that involves neuroscience is called neuroplasticity. Researchers have found that our brains are constantly changing from the time we are born until we die. Our brain can build new neural pathways when we replace an old habit with a new habit, or change our attitude or lifestyle.
New neural pathways can be formed when making wise financial decisions. Let’s assume you want to save money for an upcoming vacation, and you commit to not buying soda and junk food at the grocery store today. You estimate you saved $15, and you put the $15 into an envelope for your upcoming vacation. If you stick with your commitment, doing the same thing next week will become easier. You continue for one month, and this small change results in saving $60.
Recognizing that you can save money will give you confidence to increase the percentage you are contributing to your 401k at work. You may decide to search for a less expensive cable or cellphone package in order to save more money. You may decide to open a Roth IRA, or talk with your kids or grandkids about money. You may decide to start learning more about investing.
These are all positive steps toward wise financial decisions. In addition to creating good habits, you are creating new neural pathways in your brain. The idea that we can “retrain our brain” is exciting!
