Why we make silly financial decisions
Behind every supposedly rational financial decision we make are many irrational brain and behavioural processes going in. Our hormones, our neurons and more are controlling our spending, saving and other economic decisions.
Both neuroeconomics and behavioural economics focus on this behaviour along with intersecting research from finance, economics, psychology and other fields such as management.
Every year new knowledge around the dumb financial decisions we make is added thanks to a wide array of studies, which often use technologies including functional magnetic resonance imagine (fMRI) to scan participants brains as they do everything from shop to cheat.
Over the past 20 years we’ve learned about cognitive biases such as herd mentality and loss aversion and been introduced to concepts such as nudges. Understanding these concepts can change your life.
There is always something new such as research by Sebastian Speer and colleagues from the Center for Neuroeconomics at the Rotterdam School of Management, who have not long published research on the neural mechanism underlying cheating. Some people can cheat without blinking and others blush or out themselves whenever they try.
The researchers used neuroimaging to measure neural activity while both predominantly honest and dishonest people worked on a task where they could cheat. Both groups cheated, one using
cognitive control to override their moral self to profit but maintain selfimage, and the other to behave more honestly than they would naturally.
Speer’s research also identified that the brains of honest people showed higher connectivity between brain regions associated with cognitive control and self-referential thinking. People inclined to dishonesty were driven more strongly by rewards, which helped them cheat, but maintain a positive self-image.
Ananish Chaudhuri, Professor of
Experimental Economics at the University of Auckland, says: “Faced with an opportunity for pecuniary gains, the prefrontal cortex must reconcile conflicting signals sent by one part of the brain that reacts to rewards, even if illegal, and another part that assesses the morality of that action. For cheaters, the reward message usually wins out. But even the honest are, at times, able to tamp down the moral message and accept the reward message.”
The ability to pick winning stocks is something that many profess to be experts at. Brian Knutson at Stanford University in California and his colleagues fMRI to measure brain activity in areas associated with rewarding experiences and riskavoidance. They found that activity in the risk avoidance area of the brain was better at predicting what actually happened to stock prices than the same participants conscious predictions about which investments would do well the next day. Knutson previously used the same technique to determine which videos would go viral.
Chaudhuri points out that cognitive control plays a crucial role when avoiding getting caught in market bubbles and subsequent corrections (crashes). “Those who have better cognitive control are better able to avoid coming under the spell of animal spirits and getting caught up in bubbles,” he says.
That’s why, says Chaudhuri, investors with a moderate amount of wealth get the best return from investing in an index fund or buying a diversified portfolio instead of constant trading.
Another area where individuals have misguided confidence in their abilities is in detecting deepfakes (hyper-realistic manipulations of video content). European researchers Nils Ko¨ bis, Barbara Dolezalova and Ivan Soraperra found in their research: “Fooled twice” that not only are we fooled by deepfakes and overestimate our ability to recognise these videos, which can be used to defraud us.
But even given financial incentives, participants in the research failed. The researchers found humans adopt a “seeing-isbelieving” heuristic (mental shortcut) for deepfake detection while being overconfident in their detection abilities.
“The combination renders people particularly susceptible to be influenced by deepfake content.”
For some easy to read books that touch on these subjects, check out virtually anything written by Dan Ariely and Daniel Kahneman.
For a more academic approach on this and neuroeconomics, try Chaudhuri’s