Investing is one of those things that really presents a problem for our caveman brains. You can explain the virtues of a long-term approach to your clients until you’re blue in the face — and they may even agree with you. But our most primitive instincts can derail long-term plans.
When its crunch-time, we’re hard-wired to reach for short-term gains, according to Dr. Ravi Menon, Canada research chair in functional and molecular imaging at The University of Western Ontario. Menon is an expert in neuroimaging, peering into which parts of the brain light up when we are presented with different situations.
“Different parts of the brain are responsible for different reactions,” says Menon. “By understanding what is happening in our brains during the decision-making process, it becomes easier to take a step back and listen to reason, rather than emotion.”
When faced with a risky decision, two distinct areas of the brain kick into overdrive. The ventral medial prefrontal cortex processes the lure of a big gain, while the dorsal medial prefrontal cortex processes the fear of risk.
Each part of the brain dates back to a time when the risks and rewards were far more visceral. The risk might have come from a larger animal, like a wooly mammoth bearing down on primitive man. The reward might be the same animal, however, if the hunter is able to kill the beast and feed his family.
In this example, fight-or-flight decisions made in a heartbeat can decide whether the mammoth or the hunter will carry the day. Today, however, investments should be thought over more thoroughly, as decisions are rarely required so quickly, and are seldom life-or-death in nature.
“This ‘battle of the brain’ is classic greed versus fear. Your emotions can easily get the best of you in these scenarios,” says Menon, who has teamed up with TD Waterhouse to help explain how the inner workings of the mind can affect investment decisions.
“Fear can be a major obstacle to successful investing, causing you to behave irrationally and do things you might regret,” says Patricia Lovett-Reid, senior vice-president, TD Waterhouse. “It is important to build a portfolio suited to your risk tolerance and be invested for the long-term. If you know you have time to let your investments grow, fear-inducing dips can come and go without making you nervous.”
Lovett-Reid points out that engaging a financial advisor can help take the emotion out of investment decisions, as the professional can help weigh the pros and cons of each decision.
The advisor’s nemesis in this process can be the nuclei accumbens, a part of the brain responsible for feelings of happiness. When a client realizes a healthy gain on an investment, they are bound to feel happy, and this part of the brain encourages them to pursue more happiness-inducing gains.
“The trick with investing is to make that feeling of happiness last-without taking on too much risk,” says Lovett-Reid. “It is important to employ strategies that don’t tempt you to chase risky short-term gains. Happiness can come from being disciplined, focusing on your long-term goals and avoiding the temptation to try and time the market.”
Taking a long-term view can help encourage longer-term happiness, as the client reaches various milestones in their financial plan. Rather than being happy with a short-term gain, it is better for the client to derive their happiness from the advice they are receiving.
“Remarkably, brain imaging studies can show us how measured advice from trusted sources can tilt the brain’s emotional decision-making biases towards a more long-term view,” Menon adds.
(10/12/10)