While societies continue to evolve and grow, the way our brain is wired remains the same. That means that our brain responds to certain types of emotions and stimuli in the same ways that it did 50,000 years ago. There’s a specific part of our brain functioning that is important to understand when it comes to finances, and that’s the amygdala. Located in the area of the brain called the limbic system, the amygdala is responsible for all of our emotions, emotional behavior, and our motivation.
The amygdala is what causes us to fear what we don’t know, as well as controlling how we react to certain stimuli. For instance, it’s the amygdala that determines how we handle situations where we feel scared or threatened. You might know this as the “fight or flight” response. We are born wired to react to unexpected events in ways that can either save our life or cause us to make ridiculous errors.
Similar to how the amygdala is activated when we find ourselves in a dangerous situation or confronted unexpectedly, the amygdala is also ignited when we experience financial loss. Our brain reacts to a volatile stock market in the same ways that it would respond to a bear attack. Obviously, this can be detrimental to your long-term financial plans, so it’s important to fully understand just how our brains and our emotions interact with our money.
How to Pick the Right Stock While Handling Uncertainty
As a general rule, our brains crave certainty. We tend to like to know what’s coming up in the future, whether it’s planning with our friends, knowing what we’re going to be eating for the week, or how we foresee our future playing out, people feel most comfortable when they know what to expect.
However, it’s impossible to predict the future for certain. We simply can’t know what’s waiting for us in our personal lives, our financial lives, and especially in something as unpredictable as the stock market. This leads to most investors making poor decisions with their investments. In March of 2020, Dalbar released its annual QAIB report (Quantitative Analysis of Investor Behavior). In the report, Dalbar relayed the details of a study they did on investor response to the volatile markets in the face of COVID-19. The results of the study suggested that “the behavioral effects of the market crisis will outlast the crisis itself.” Chief Marketing Officer at Dalbar commented, “If there was one thing that the average investor can take away from our study, I hope it would be this: you are unlikely to correctly time your reentry point. So, while getting out of dodge may seem to mitigate losses in the short run, it has often intensified losses over the long run.”
This report provides just one example of how our emotions can often lead us to make rash financial decisions, especially with regard to investments. These decisions can often lead to more loss down the road.
Finances & Emotions: Left Brain vs. Right Brain
So how can we, as investors and managers of our money, mitigate our emotions and make better financial decisions? Typically, the more we understand something the more power we have to control it – especially when it comes to our emotions and behaviors. Understanding how the brain works and how it regulates our emotions can do wonders for managing our financial decision-making.
Often, you’ll hear people describe themselves as being either left-brained or right-brained. Past experiments and studies have shown that the two hemispheres of the brain are responsible for vastly different manners and styles of thinking. The right side of our brain is more creative and visual, it processes information intuitively it’s the first to make judgments and decisions, and it often utilizes first impressions to help keep us out of trouble. Usually, we rely on the right side of our brain to give us a quick assessment of what is happening. Then, if we need more information, the left side of our brain takes over. The left side of the brain is analytical and logical, it uses reason, facts, and science to make decisions.
Which Brain is Right for Investing?
In his book, Thinking Fast and Slow, Nobel laureate Daniel Kahneman introduces the argument that our right brain is incapable of considering risk and return simultaneously, and therefore takes on investment decisions in a reactionary and harmful way. Instead, Kahneman asserts that our left brains are what must perform the task of analytical thought that the right brain lacks. To Kahneman, since the left side of our brain is where slow thinking happens, it is able to recognize and change the biases inherent in the decisions made by our right-side brain.
Investors who are more left-brained tend to examine all of the facts and reasoning before making a choice between risk and return. They look at the past figures and future probabilities, consider overall portfolio construction, fund expenses, turnover, diversification, taxes, and other relevant factors. Thinking in this analytical way provides the opportunity to uncover issues with investments that right-brained people may miss. However, this kind of thinking can be emotionally and mentally exhausting, which is why we often depend on the right brain to kick in and come to the rescue by providing emotional relief from left-brained analysis
Like with most things, hastily made decisions often come back to bite us in the end. When it comes to investing, relying too much on the right side of our brain means that we may make hasty decisions based on hunches that end up hurting us long-term. Right-brained investors may find that they spend a lot of time fretting over past mistakes and speculating about what the future holds. However, the fact of the matter is, there are no solutions to failed events of the past nor any possibility to plan for an uncertain future. The only place where solutions can be found in the present.
No matter if you’re more right-brained or left-brained in thinking, it’s crucial that you understand what your natural tendency is so that you can better learn to control your reactions to what happens, what you see, or what you hear and interpret from outside sources. Ultimately, it comes down to finding the right mix of left and right brain thinking for you.
Concluding Thoughts About Finances & Emotions
Many investors are more inclined to make decisions based on their intuition or gut feelings, relying on the wrong side of their brain to solve serious financial problems. It’s true that our emotional state of mind plays a crucial role in making intuitive decisions and judgments, but these decisions are guided by feelings of liking or disliking something rather than by rational deliberation or reasoning. When confronted with a significant financial decision, remember to take a pause and ask yourself whether you’re relying on intuition or reason as you make decisions.
A great way to ensure that you’re keeping your emotions out of your investment decisions is to have a professional in your corner that you can trust to help walk you through the big financial conundrums you’ll face throughout life. At Arcadia, helping you stay on track to achieve your financial goals is our top priority. If you’d like to sit down with one of our professional advisors to talk about creating a long-term financial plan that’s free of emotional impulses, please contact us today. We look forward to hearing from you!