What is Really Driving Your Financial Decisions?

A brain scan was taken just before an individual placed a stock trade. Another brain scan was taken just before someone was given a hit of cocaine. In both cases, the brain was flaring up in anticipation of a gain, and the scans were virtually indistinguishable.

Contrary to what we like to believe, decisions are made with the right side of our brains. This statement is controversial because we generally believe that we are rational people and make most decisions after an objective evaluation.

With respect to our financial decisions, 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 make our financial decisions based on rational thought. In reality, we frequently make decisions before we are consciously aware of them and then attempt to rationalize them before we act. We must not confuse this with rational thought.

The left side of our brain tells us the two scenarios outlined above are different, but our right brain can not tell the difference. The left brain tells us that drugs are bad, and making money is good. The right brain simply knows is that we are about to benefit from something.

One of the things that makes us human is the ability to engage in rational thought. Unfortunately, this often results in bouts of overconfidence in our ability to control our emotions.

The brain scans above outline this phenomenon perfectly. Through rational thought, we have the ability to control our urges by recognizing the inherent danger in certain situations. However, we often neglect to acknowledge that danger when it applies to money (or we greatly underweight it), as we are conditioned to believe we ought to pursue more of it.

We must also recognize the overpowering nature of our emotions in reverse. Rational thought would not have led to so many people’s decision to bail out of the market (or not rebalance their portfolios) in 2009. Rational thought would have prevented millions of homeowners from purchasing homes with little or no money down. Rational thought would result in everyone spending less than they earn and planning more for the inevitable uncertainties in life.

We can not change how we are biologically wired, but we can make consistently better decisions by simply acknowledging how and where they are actually made. Like the 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. We insulate ourselves from the dangers of drugs through avoidance. It would serve us well to do more of the same in our financial lives.