Neuroeconomics help us understand why we make the financial decisions that we make.
The most important task we perform in life is decision making. In no area could this be more apparent than in the area of financial decisions. Financial decisions not only affect us daily, but also have long-lasting effects on retirement.
Enter the new world of neuroeconomics, the study of the biological foundation of economic thought. This discipline, in conjunction with behavioral economics, is shedding light on this murky area. Behavioral Economics is the incorporation of insights from psychology and other social sciences into the study of monetary behavior.
For example, the brain’s pleasure center (nucleus accumbens) is stimulated in accordance with our partiality for an item. This can be measured using Functional Magnetic Resonance Imaging (FMRI), because neurons in the active parts of the brain require more oxygen.
If we desire chocolate cake and it is presented to us, our pleasure center lights up. As the cake is consumed, however, the level of activity in the pleasure center quiets. The same presentation of the chocolate cake no longer stimulates it.
But, if you are buying the piece of cake on another occasion, rather than simply being offered it for free from a trusted source, this scenario takes on new complexity. Then, if the price is high, your brain’s price sensor (insula), from deep within your brain, is activated. It can suppress the excitement of the pleasure center. This may result in you declining the cake because you judge the price to be too high. It is the executive brain (prefrontal cortex) located near its surface that is the arbitrator of these dueling forces, the pleasure center (nucleus accumbens) and price concerns (the insula).
Likewise, if you have reason to think the cake is tainted with any unpleasing substance, your fear center (amygdala) is activated. This stimulation acts like price concerns and squelches your desire to eat the cake. Again, it is the executive brain that is the mediator.
Though brain interactions are much more complex than described, or even understood at this point, we now have a way to think about them that is more concrete than previously, one that enables us to visualize the process. For some people, imaging these brain interactions when they make decisions, including financial, help lead them to better selections.
Next month, I will address the Endowment Effect. This is a bias in our thinking by which we value something we already own more than an equivalent item we do not own. It influences us frequently. Now, Neuroeconomic studies tell us why.
Shirley Mueller, MD is a physician turned financial consultant and investment educator who specializes in guiding clients, both one-on-one and in groups, about how to effectively self-invest using a simple and effective three-step approach.