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Your Money and Your Brain

February 25, 2008

Tags Financial MarketsPhilosophy and Methodology

Comedian Jay Leno recently had a bit about pilots wanting passengers to take on the responsibility of subduing terrorists on the plane. "First I had to start pumping my own gas, then I had to scan my own groceries at the checkout counter, now in order to fly, we must be responsible for making sure terrorists don't hijack the planes?"

Yes, a cruel combination of inflation and labor laws is breaking down the division of labor. But forget the indignity of pumping your own gas, what is most damaging to balance sheets and retirement nest eggs is that people now must manage their own investment portfolios.

The days of defined pension plans are gone, unless you are a government worker. The rest of us are left to manage our own 401k's, IRA's and any other extra money that the government doesn't grab by overt taxation — or the stealth variety of inflation.

Unfortunately most people's brains are just not equipped for the task. Smart people make stupid financial decisions according to Jason Zweig, who takes us on a tour of the investor's brain in Your Money and Your Brain: How The New Science of Neuroeconomics Can Help Make You Rich.

Of course that "help make you rich" part is the kind of hyperbole that sells books and likely sends a dopamine rush to the brain of a book-buying investor. The brain has 100 billion neurons and only one-thousandth of one percent produce dopamine, but "this minuscule neural minority wields enormous power over your investing decisions," cautions Zweig. One would think he would be more careful with the titling of YMYB.

Dopamine takes as little as a twentieth of second to reach your decision centers, estimating the value of an expected reward and more importantly propelling you to action to capture that reward. "We've evolved to be that way," explains psychologist Kent Berridge, "because passively knowing about the future is not good enough."

Of course the effect of all this is what Zweig refers to as "the prediction addiction." Humans hate randomness. We want to predict the unpredictable, which originates in the dopamine centers of the reflective brain, according to Zweig, leading humans to see patterns where none really exist. The whole technical analysis field that Wall Street embraces, is based upon the human desire to predict and when seeing two occurrences in repetition, people believe (or want to believe) that a trend is in process that, most importantly, they can profit from.

When Parkinson's patients are given drugs to allow their brains to be more receptive to dopamine, they have the insatiable urge to gamble. When these drugs are stopped, the gambling stops immediately. But unfortunately, when we get what we expect, no dopamine rush ensues. "A reward that matches expectations leaves your dopamine neurons in a kind of steady-state hum," writes Zweig, citing the research of Read Montague and Wolfram Schultz. "[G]etting exactly what you expected is neurally unexciting."

So, like drug addicts, who need to take increasing amounts to get the same fix, investors must speculate in increasingly riskier investments to achieve the same dopamine kick. And unexpected gains really fire up the dopamine. Neurophysiologist Schultz explains that the "dopamine system is more interested in novel stimuli than familiar ones."

Zweig also explores how humans are overconfident in their abilities. That our perceptions of investment risk are in a constant state of flux, depending on our memories of past experience, and most of our fears about finances are misdirected.

Okay, so to read Zweig, we're just a bunch of neurotic gambling junkies looking to get high from either playing slots, going to bingo night, or rolling the dice on penny stocks. What's a prudent person to do? You'd be surprised. Sure, Zweig counsels us to put our money in mutual funds and forget about picking individual investments. But he goes further, stressing that we should try to find happiness. He says to breath deep to reach an inner calm, turn off the tube to stop envy, surprise someone with an unexpected gift raising both yours and the receivers dopamine levels, and try something new each week even if its just reading a different magazine to gain new perspective, are just some of Zweig's ideas. He also warns the elderly that aging makes us accentuate the positive and eliminate the negative, making old people susceptible to con-men, shysters and their get-rich-quick schemes.


Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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