Emotions tend to guide our financial decisions -- often leading us to make mistakes with money. But studies show that embracing your emotions when making financial decisions can sometimes be helpful. Example: If you feel like you're being ripped off, you probably are.
According to modern portfolio theory, investors try to maximize the expected return of their portfolios for a given level of risk. Evidence speaks otherwise. Many individuals don’t make economic decisions in their own best interest, because their emotions get in the way.
This scenario can cut both ways, however. Sometimes feelings protect the decision maker. Recognizing and using this concept to your advantage is just as important as being familiar with the potential for financial devastation that emotions can bring. For example, when a buyer believes that a price for an object is too high, his brain acts on his behalf and squelches his desire to purchase the object. It protects his comfort level, because the shopper would feel distressed if he felt he paid more than he should.
Likewise, if another shopper believes she may be a victim of deception, such as a “bait-and-switch” scam, her brain will turn away from an offer. For example, Eli Lilly, a prominent art collector in the first half of the 20th century, pulled out of a potential art deal unexpectedly and quickly.
In 1948, Lilly was offered eight Chinese hand-painted scrolls from C.T. Loo, also an important person of the time and a New York-based dealer in Chinese art. Two of the scrolls interested Lilly, who resided in Indianapolis. He expressed his interest in a letter to Loo. But when Loo sent the merchandise to Lilly on approval, the cost of one of the scrolls had increased in price by $2,000. Lilly promptly backed out of the sale.
According to studies by Julie Grezes, Ph.D. and her colleagues at the Laboratory of Physiology and Perception in Paris, and others by the Wellcome Department of Imaging Neuroscience at University College in London and the Department of Experimental Psychology at the University of Oxford in Oxford, U.K., Lilly’s fear center, or amygdale, was almost certainly activated when the quoted price for the scrolls was suddenly increased. The amygdale is considered part of the primitive brain, such as the pleasure center or nucleus accumbens, and the price-concern region known as the insula. It is stirred when we feel someone is acting deceptively toward us, as well as when we are fearful. Grezes, who studied this phenomenon, said that his results suggested that, “When one is personally involved, deceit is taken as a potential threat.”
In the study of Grezes and her colleagues, the researchers wanted to tease out whether personal involvement influenced the neural response associated with the detection of deceit. In their ingenious experimental design, they asked subjects to watch videos of actors who lifted boxes and judged whether they had been misled about the weight of the box. Among the subjects were some of the actors who actually had lifted the containers and been mislead.
As it turns out, the actors who had lifted the boxes were the only ones who showed functional MRI activity in their amygdala during the study, and it occurred when they observed themselves on the video being deceived. Increased flow was also present in their fusiform gyrus also at that point, a component of the social cognition neural system. The other parts of this integrated pathway include the superior temporal sulcus and anterior cingulated gyrus, both activated when participants detected that the experimenter had deceived either themselves or others.
When our brain makes a decision it is like a balancing act -- it employs intellect represented by the mesial prefrontal cortex, part of the modern brain. It also is influenced by emotions emanating from the primitive brain. If desire, from the nucleus accumbens, has no offsetting pressures from elsewhere in the brain, the mesial prefrontal cortex will act on it and a purchase will be made. If price is an issue that counterbalances desire, it can sway the mesial prefrontal cortex away from making a purchase.
Perceived deception or fears do the same. These emotional influences on the final choice can be protective and even prevent disaster. This means that embracing emotions during a financial decision can sometimes be helpful, rather than solely harmful, as previously thought.