The truest essence of what it means for us to be human, I’m convinced, lies more within our brains than inside any other of our numerous, marvellously created organs. That’s why the economic strata of life we rise to, or perhaps fall from, our early family and social circumstances are determined more by the quality of our thoughts than by any other factor.
A decade ago in his insightful 2007 book Your Money & Your Brain, Jason Zweig, the personal finance columnist for The Wall Street Journal and a world-class investment thinker, wrote: “... you’ll never maximise your wealth unless you can optimise your mind.”
Unfortunately, not many of us have taken the proactive steps needed throughout our adult years to learn to optimise our mind so as to become better wealth protectors, wealth accumulators and wealth distributors. But while there is breath, there is hope!
Just because we’ve never made it a goal to recruit our amazing brains in our quest for wealth-building, doesn’t mean we can’t turn over a new leaf and start today!
The simple premise of Zweig’s complex book is that if we better understand how our brains tick, we might improve how we manage our personal finances. That’s why the subordinate title of Your Money & Your Brain is How The New Science Of Neuroeconomics Can Help Make You Rich.
I trust that’s grabbed your attention.
Note: If you aren’t familiar with the term “neuroeconomics”, don’t feel bad; relatively few people are.
UNDERSTANDING NEUROECONOMICS
Neuroeconomics is a new field of scientific endeavour that was birthed within the fertile intersection of three older disciplines: neuroscience, economics and psychology.
In 2002 the Nobel Prize for Economics was awarded to neuroeconomics pioneers Daniel Kahneman and Vernon L. Smith for pushing through the staid boundaries of traditional economics into the fascinating realm of human brain architecture.
While the lessons about our money and our brains are too numerous and too complex to be adequately outlined in a column, or even a string of columns, it is nonetheless profitable for us to focus as sharply as possible upon the most pressing financial problems we must solve. But as Zweig points out, we can’t begin to solve a problem, any problem, until we know what caused it in the first place.
Yes, that’s just common sense. But I have learnt over several decades that common sense is seldom common practice! For instance, I have faced three recurrent challenges with potential and existing clients of my financial planning practice for whom it makes sense for me to design, build and manage multi-decade retirement funding portfolios comprising three, four or five asset classes.
Those common challenges all hinge on a disconnect amongst how many of us think about our money, the true emotions we feel when investment markets swirl and news headlines whirl, and what is ultimately beneficial for our long-term financial well-being:
1. Over-estimating risk tolerance when markets are rising because of our mounting greed;
2. Under-estimating the need for volatile risk-on assets when markets are falling, because of our visceral fear of loss; and
3. Latching onto random news items as catalysts to abandon well-thought out long-term investment strategies because of our knee-jerk interpretation of surprising stimuli.
Those three challenges are part of the reason I choose to accept only a few new financial planning clients each year. It’s exhausting having to repeat key teachings on personal finance to those who are constitutionally or emotionally resistant to learning key lessons on money.
Thankfully, in contrast, it’s an absolute joy to guide motivated individuals who are eager and willing to learn potentially profitable, time-tested money lessons. That, incidentally, is why I spend a lot of time one-on-one with clients testing and re-testing their basic understanding (and, sometimes, shocking misunderstanding) of the overarching risk-reward relationship as it applies to investments. In a way, those hopefully engaging sessions are my low-tech probing way of learning what can also be unearthed rather differently within sophisticated laboratories.
Zweig explains: “... over the past few years, scientists have made stunning discoveries about the ways the human brain evaluates rewards, sizes up risks, and calculates probabilities. With the wonders of imaging technology, we can now observe the precise neural circuitry that switches on and off in your brain when you invest.”
So buy a copy of Zweig’s book and commit the next few weeks to reading it, studying relevant portions, and tweaking your default ways of handling money. You do so by growing aware of your reflexive thought processes on money.
The most important contribution neuroeconomics can make to the financial decision-making processes of regular people is to help us grow more aware of our internal reflexes that often derail our best plans for the long-term compounding of our personal and family wealth.
That’s why I plan to devote my next three columns to exploring how neuroeconomics might help us better understand the human brain’s reactions to greed, fear and surprise.
Doing so should help us grow better at understanding and handling money; so stick around for what I hope will be a profitable journey of self-discovery...
Rajen Devadason, CFP, is a Securities Commission-licensed financial planner, professional speaker and author. © 2017 Rajen Devadason
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