You are interested in investing in land or shares or anyother ? Reason to be careful.
You buy a risky investment impulsively. You beat yourself up over an investment that's losing money, but you can't bear to sell it. For most investors, these types of irrational, shortsighted decisions are normal and automatic But with the help of a new branch of science, neuro-economics, investors can learn how to resist their self-destructive tendencies.
Neuro-economics shows that our brains are wired with two different systems, each struggling for control of our financial decisions. The prefrontal cortex brain (cortex) is highly evolved and rational. The limbic system (limbic), is more primitive and reactive. All too often limbic takes control, even when it's not in our interest.
Experiments reveal that limbic can be striking. Researchers at Stanford had students play a simple game in which they could win or lose money depending on how quickly they pushed a button. During the game, an MRI machine scanned the students' brains. Scientists discovered that the thought of making money pushed the reward system of the students' brains into high gear. That system releases dopamine, the pleasure chemical of the brain. The bigger the perceived reward, the more dopamine. The more dopamine, the more emotions control your decisions.
Sexy but dangerous
Although the experiment didn't focus on investing decisions, you can draw some conclusions. If you're thinking of how sexy an investment is or how fast its price is rising, but not thinking about how it compares with other investments, means if you're acting on the basis of excitement, you'll make bad decisions.
Moreover, when we see opportunities for big rewards, we tend to downplay the potential risks. The part of the brain that kicks in during the presence of high-reward opportunities responds to how much you think you can make, but not probability. It's like you are drunk and are going after the hottest woman at a party.
The two systems also come into force when you must choose between long-term and short-term gratification. Put simply, the emotional system is impulsive and myopic. Brain scans show that the promise of an immediate reward set off an emotional response, limbic wants things now.
But when given a choice between rewards of varying amounts at different times in the future cortex prevailed. For example, offered a choice between a $5 gift certificate in two weeks or a $40 one in six weeks, most participants in the above mentioned experiment delayed gratification for the larger reward down the road. Our emotional brain wants fun now, our logical brain knows we should save for retirement and go for health.
Our emotional brain – limbic - is incapable of thinking about the future. Neuro scientific research discovered that Vietnam veterans with injuries to cortex struggled when making long-term financial decisions. They had a difficult time articulating goals for the future, especially far into it, such as planning for retirement or saving for their children's education.
Another component of our neural wiring that hamstrings financial decision-making is that we are programmed to see patterns. At a very deep level, it's what our brains do. This ability is useful in the natural world, where there is often good reason to assume a pattern is meaningful. In the days when humans were hunter-gatherers a man who found three nests that contained eggs would check a fourth nest.
Nowadays, though, that kind of assumption could cause problems. For example, you see red come up three straight times on a roulette wheel. What do you do? Bet next month's mortgage payment on red?
In investing, the pattern we see is often a coincidence. But the subconscious part of our brain urges us to act on this pattern. It may override the rational part, which may see, for instance, that your targeted investment has become wildly overpriced.
The broken pattern
Now what do you do if you reach into that fourth nest and a snake bites you? You'll almost certainly start giving nests a wide berth. When a pattern is broken, your brain generates feelings of fear and revulsion -- which is a good thing because it lessens the likelihood of future snake bites. But that is not necessarily a desirable outcome for investors. If a company releases a poor earnings report, you may sell the stock even if it is still a sensible investment, or you may be so disgusted that you do nothing when, in fact, you should sell the stock.
Because our minds are wired to avoid the unpleasant. Bad memories last much longer than good ones as positive stimulations are short-lived. Those mechanisms turn on and off quickly. But if you're scared by a saber-toothed tiger, you'll be scanning the bushes for the next three years.
Trusting patterns is one thing. But what about trusting people? Science has something to say on that subject, too. The trust game has become a staple of neuro-economic research. Variations exist, but basically the game involves a trustee and an investor. The investor sends the trustee money and the rules of the game say that that mere act automatically expands the amount of cash. The trustee may then share the wealth with the investor and return some of the money or -- and here's the rub -- the trustee may burn the investor and send back nothing.
You might think that behavior in such a game would be based on a simple financial calculation: I'll send more money if I get more back. But trust is an emotional response. The hormone oxytocin fills different areas of the brain in social situations, such as bonding between spouses or between parents and children. We are a social species, and it's a good thing that we can learn how to trust. As a certain amount of cooperation between parties benefits both of them. Just how powerful is oxytocin? In a version of the trust game researchers discovered that simply squirting a dose of oxytocin up a test subject's nose prompted the person to give the trustee more money.
What’s the solution?
Although neuro-economics identifies the reasons for our actions, it's less helpful in prescribing corrective measures. But that doesn't mean you have to wait a few hundred thousand more years for your brain to evolve to the point that you can approach your finances more rationally.
The overarching rule is that investors must learn to recognize situations that will set off emotional decisions. Then you can place yourself in a circumstance that doesn't require you to make snap decisions. When it comes to trust, for example, you shouldn't act on someone's financial advice just because you like the person.
If you are presented with a high-reward opportunity -- say, a broker calls with a hot tip on a penny stock -- wait. Acting on impulse means you won't properly weigh the risks involved. Let your rational brain part spend some time researching the investment -- no sense in having a highly evolved brain if you don't use it. And be aware of patterns. Sometimes they're valid, sometimes they're not. Get the big picture about your possible investment before investing.
Follow these other simple rules, and you stand a much better chance of moving the investment decision-making process into the rational part of your brain:
Don't fixate on the short term. A daily, or even hourly, diet of news fires up your emotional brain part and can trigger fear and greed, two emotions that often trip up investors. In the same vein, don't check the prices of your investments too often.
Set long-term goals for your investments. Research has shown that as soon as you stop thinking short term and start thinking about the long term, the emotional part of your brain shuts off.
Diversify and examine the performance of your portfolio as a whole. Big rewards and big losses set off emotional responses. A diversified portfolio evens out these ups and downs.
Set a timetable for when to sell stocks and other investments. That sell discipline creates rational goals and preempts emotional reactions.
That’s it for this one.

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