Money and Minds

A study in the May issue of Psychological Science looked at people’s cognitive performance when they were feeling high or low in personal power. Smith, Jostmann, Galinsky, and van Dijk randomly assigned participants to a low-power or high-power group and then tested their executive functions, processes in the brain that guide behavior according to one’s goals and organize and sort information.

They found that people in the low-power group were less able to focus on their goals and to plan out strategies to meet them. High-power participants were more efficient and made fewer mistakes, even though motivation and effort were the same between the two groups.

Smith et al. suggested that their findings have direct impact in the workplace–that empowered employees will also perform better–and demonstrates how hierarchies persist: the people in power do their tasks well, while the people without power do poorly and can’t become empowered. This could also have social and economic implications. We’ll pass over the social aspect, but consider the impact this might have on your financial decisions. If you don’t know much about finances–and nobody starts out knowing a lot–you won’t feel empowered. And if you don’t feel empowered, you’ll make mistakes, mistakes that could cost you money and peace of mind.

Some people say, “I don’t get investing,” and let it go at that, but doing so could cause more problems than you might think. When people feel likely to fail at something, they tend to stop trying and find an external source to blame, something like “finances are too hard” or “it wasn’t my fault, I never learned about this.” This is called self-handicapping: behavior that deliberately (if subconsciously) sets up oneself for failure in order to proactively find something else to blame for the failure.

The lesson here? Avoid unconsciously handicapping your financial future. Empower yourself when it comes to finance. Simple steps will give you a feeling of knowledge and control.

• Ask experts. Your banker and your stockbroker and even your employer’s HR department (in the case of 401ks) are there to help you learn more about your money and the things you can do about it. Banks will sometimes offer seminars on the basics of investing and retirement funds.
• Read. The bookstores and libraries are awash in personal finance books. The Internet is full of advice–good and bad–and sites to give you information and personal experiences. (For example, the blog Get Rich Slowly has a number of reviews of personal finance and other books that I’ve found useful.)
• Talk to the people you know. Maybe your parents have a nice mutual fund. Maybe your brother knows what buying margin means. Maybe your best friend’s sister tried credit card arbitrage and can explain where she went wrong.

The most important thing to remember is that feeling overwhelmed will cause you to make mistakes…and it’s easy to correct. Learn all you can. Knowledge is power…and power is, apparently, a big part of proficiency.

Categories: Psychology
Tags: empowerment, Psychology, self-handicapping

This is a rant and a question about something that really bugs me. I spend quite a bit of time reading financial news, primarily on the Internet, and I am struck by how much writers and commenters wish for bad economic news, the worse the better. It is a widely accepted belief that if you want to start a successful paid financial blog or website it is better to concentrate on a negative subject.

Many times an article with a positive slant on the economy or job statistics or the housing market will be followed with numerous comments proclaiming the sector involved is in the middle of a deep recession that will last for years, decades, forever, etc. Here are some of the more virulent topics, first, with what I see as factual, followed by some common perceptions:

• U.S. economic recession: Although government statistics show the economy is still growing, although at a slow rate and the historical average recession lasts 6 to 9 months many Internet opinions put us well into a deep recession that will last for many years.
• Worldwide economic recession: Economic growth is healthy in most parts of the world with strongly growing economies in most regions. Again, however, many expounding on the Internet are convinced the U.S. ‘monster’ recession will drive the rest of the globe into recession or vice-versa.
• Sub-prime credit crisis: The failure of the sub-prime mortgage market has hit many financial institutions hard and has caused a real recession in the housing market. Reading the internet and following the financial stocks would have one believe no bank will ever make a profit again or even survive.
• Inflation/Stagflation: Rising commodity prices, especially oil, have caused many prices to increase. Many in the Internet world do not believe any government statistic on inflation and fear U.S. monetary policy will drive us deeper into the multi-year, multi-decade recession they are all wishing for. Or so it appears if you read enough of this stuff!
• Housing market: From about 2002 until near the end of 2006 real estate prices and new home sales shot up at unprecedented rates. Since 2006 home prices have generally fallen and home building has been severely curtailed. Now home building rates and prices are back to somewhere around the 2002-2003 levels. Internet pundits keep comparing their data to one year ago or peak rates and project the current slow down all the way to zero. Many I read will not be happy until everyone’s home is worth $1,000.

This type of stuff really bugs me. First, of all I am a positive guy and want to make money by investing in positive ideas. An investment that goes up in value is positive. I do not see the value of all of the negative prognostication, especially on finance/investment internet sites. Excepting of course, the financial sites pushing this stuff and making some serious coin! Second, I have been watching financial news a long time, and everything goes in cycles, especially herd mentality and stupidity. And the herd includes everyone from bank CEOs to Wall Street numbers geeks to your neighbor getting-rich-on-investment-real-estate-with-no-money-down until it all collapses. The long term trend of economies and markets and real estate are to grow in value, but these are not straight line trends. There are many ups and downs along the way. As an investor, I want to find the places in the trends where I can make more money than putting my cash in the bank or T-bills. Projections of impending or current doom and collapse do me no good.

So my question again is: What is the appeal of all of the negative financial scenarios in the news? Why aren’t more people interested in stories that show them where things are positive and there are money making opportunities? Or are the positive money makers happy with their lot, and leave the doom pounding to those without the ability to find positive investment stories to help them make money? I look forward to reading any comments on this subject.

Categories: Economy, Investing, Psychology
Tags:

“We’re putting all our spare cash into the stock market right now,” my coworker M said to me not long ago. “I figure that it’s cheap to buy right now, and prices are bound to go up.”

“We had twelve thousand dollars in the stock market,” my friend J said to me not long ago. “Then when everything came down it was ten. Now it’s back up to eleven. But we’re sure not doing anything with stocks until it gets back up to twelve at least. We can’t afford it.”

There are differences between M and J, of course–one is that M is in a household with two good incomes and J is in a household with (temporarily) one fair one–but they also have different perspectives on investing. Following up on Tim’s post, different people can look at the same world situation–a depressed stock market in which prices which had been rising have fallen and are slowly climbing again–and have radically different reactions.

As Tim said, the price you pay or how you feel about an investment doesn’t affect its outcome–but it does affect yours. Buying stocks cheaply now may well be a good move; but even if J had the money, she probably wouldn’t do it because she’s risk-averse and has just suffered a loss, which increases her risk aversion. M, on the other hand, is relatively risk-loving. If both of them were given the same opportunity–for example, the chance to buy stock in a company being touted as the next Google–chances are that they would react differently, even if they have the same information about the market and the absolute risk, based on their investment styles and their previous experiences.

It’s worth considering whether your previous experiences are coloring your thinking when it comes to investing. Maybe you lost money recently in your portfolio. (Chances are you did; most people have.) That doesn’t mean you’re going to lose money if you make another investment. It doesn’t mean you’ll make it, either, of course. It all depends on the market and world events; but not, as Tim said, on your action or your personal history.

Categories: Investing, Psychology
Tags: Investing

This website is devoted to understanding how our cognitive illusions affect us when we make decisions concerning money. We all view the world from our own unique frame of reference, and when our view causes analytical inaccuracies we call that a cognitive illusion or bias. Or and an old friend put it; our “stinkin’ thinkin’ is erroneous!

Today I want to show a few examples of how our perspective can change how we see our investments and maybe some errors we can guard against. Let me throw out a few examples.

• First, an easy one: Every time a stock is traded, the buyer believes the stock will go up, but the seller does not. Different perspectives!

• Imagine yesterday you bought stock XYZ for $20 per share, today you look up the share price and it is trading for $30 per share, and 50% gain in one day. How do you feel?

• Another scenario: A month ago you bought XYZ for $40 per share, today it is $30 and you have lost 25% of your investment. How does that make you feel?

• Scenario, Part III: Yesterday, you got fed up with your holdings in XYZ to do anything and you sold it all for $20 per share. Today the stock is going for $30. How do you feel?

In all of the cases above, XYZ is $30 per share but your feelings about that share price are completely different. The difference is your perspective based on your purchase or sale price.

The point I am trying to make is that the market does not know or care at what price we bought a particular investment. Our perspective, however, controls how we believe the market should go based on the price we paid. We have thoughts like: My investment is down, I just want to get back to even before I sell. OR This investment has doubled for me, so I want to buy more and do it again. This type of investment thinking has no correlation with where the investment will actually go from here.

Important Thought: The price you paid for an investment has absolutely no bearing on where it is going from here! The market for that particular investment is completely separated from your buy and sell decisions once you have acted to buy or sell.

If you want to manage your own investing, be it stocks, mutual funds, real estate or ostrich farms you need to analyze your holdings or prospective holdings on current market conditions. Once you have bought or sold something, that event is done and has no bearing for the future of your portfolio. I hope this information helps you with your personal investment analysis!

Categories: Investing, Psychology
Tags:

Here’s a quick way to improve your health, the planet, and your bank account: become a vegetarian.

Assuming you’re not one already, you hated that idea, didn’t you?

Vegetarianism is arguably more of a hot-button issue than some, but substitute any radical change (try “give up your electricity”) and chances are, you’ll hate it, even if it rationally makes sense.

Generally speaking, people don’t like change, even when they know it’s for the better. A habit takes weeks at the shortest to form or break, and habits are like behavioral rules of thumb, making it easier to live our lives; of course we don’t like it when we’re asked to do something different. Thus, change takes time. But it’s not just psychological barriers that make it hard to change our behavior; it’s also because physical paths for new change must be carved out in our brains.

The brain consists mainly of neurons (brain cells) which “talk” to other neurons using chemical signals called neurotransmitters. The junctions where neurotransmitters live are called synapses. Synapses are critical in brain function; how many there are, where they are, and what neurotransmitters they contain affect memory, learning, emotions, mood, alertness, and more. Memories are commonly thought to be recorded by strengthening or weakening particular synapses and adding extra ones in certain neuronal pathways. So if you’re used to, say, defining a meal as “meat and two sides,” then it’s going to take a while for the neurons to change the right pathways, altering synapses, in order for your brain to be able to define a meal as “grain or vegetable base with protein side” (or what have you).

This doesn’t mean it’s not worth doing, of course. The brain is a marvelously adaptable thing, and the fact that the adaptation takes time because of the physical changes needed doesn’t detract from that. So the next time you try to change your behavior–perhaps by giving up your daily Starbucks or your monthly salon visit, or biking to work instead of driving–and find it difficult, don’t give up. Your brain is in the process of changing its scaffolding for your behavior, and once it’s done, your new behaviors will be hardwired into you, just like the old ones.

Categories: Neuroscience
Tags: change, the brain

If you could choose only one, would you choose to (a) save a thousand people in a foreign country from dying in an earthquake, (b) save a hundred people in your home town (but that you don’t know) from dying in a plane crash, or (c) save your best friend from dying in a car accident?

Most people will answer (c), and will choose (b) over (a). (Up the ante by changing “your best friend” to “your child” and all but the most Vulcan-like among us will answer c.) You could call it egoism–the view that humans always act based on rational self-interest–or emotionally-motivated behavior or just plain selfishness; but given the choice, people almost always choose to do what benefits them, even at the detriment of other people, especially if those other people are distant strangers.

This is healthy human behavior; we value what we have and what we know, and we act to protect what we value. Rationally, however, if we assume that human life in general is valuable, we know that (a) is the most logical choice. Most of us don’t worry too much about this, since saving one’s best friend from death is pretty big, and after all, it’s just a hypothetical dilemma.

Now let’s talk about the food crisis. Chances are you’ve heard that food prices are rising and seen it for yourself. There are a number of factors causing the higher prices: increased demand, low reserves, the weak dollar, the high price of oil…and speculators. This Washington Times article describes how investors are putting money into futures markets for corn, wheat, and rice (among other things), which actually drives prices higher.

Speculators have always played a prominent role in commodities markets, but in the past year, they have literally overwhelmed them, causing a dramatic increase in trading volume, volatility and prices and disrupting many of the normal relationships between producers and end-users.

…As with the credit bubble before it, the explosion in commodities prices has its origins in a global savings glut and massive trade imbalances…The difference this time, however, is that even before it bursts, this bubble is causing economic discomfort for households and businesses around the world, and misery for hundreds of millions of hungry people who suddenly cannot afford a bowl of rice or scrap of meat.

Generally speaking, your financial decisions affect you, your family, and maybe a corporation’s profit margin or a stock broker’s bonus. But this is a new twist in financial decision making, where deciding to make some money could mean making a family just like yours–even if it’s on the other side of the world–go hungry.

If you could choose only one, would you choose to (a) feed a hundred starving people in India, (b) feed ten hungry people in your home town, or (c) make a little extra money off the stock market?

Choosing to invest in the stock market, even in the commodities market, won’t directly bring you to that choice, of course. But it’s true that thanks to our truly global economy, your financial decisions can now truly affect people in foreign countries. What would you choose?

Categories: Ethics, Investing
Tags: dilemmas, food crisis, Investing

We all know how the more extreme addictions can ruin lives.  An addiction to gambling, hard drugs, alcohol, or anything similar can wipe out a person’s finances and ruin lives.  Thankfully, most of us have an aversion to such extremes.  However, that doesn’t mean that our less extreme choices can’t have their own bad effects.

Let’s start our look at the field of more innocent addictions with caffeine.  When we go after the root of the demand for caffeine, it seems to be in the fact that we (as a society) frequently don’t get enough sleep.  Caffeine is the solution to that.  It helps us wake up and function in the morning, and provides what appears to be a solution to our tiredness. 

This blind spot in our decision making is often supported by medical research coming out in support of caffeine offering some health benefits.  However, we all demonstrate a very specific decision making bias when we look at these effects and not at the other impacts of caffeine.

First and foremost is the money factor.  Many of us get our coffee from specialty coffee stores.  At best you might get a coffee for $2-3, more likely it’s upwards of $5 for your coffee.  For the sake of argument, let’s say a reasonable average dollar cost is $10/day.  Multiply that by an average of 200 workdays per year (assuming you drink coffee only at work) and you get a minimum of about $2,000 spent on coffee in a single year, which is far from an insignificant sum!

However, as with any addiction, to free yourself from this, you need to look at the factors involved.  First is the physical addiction.  As mentioned before, we’re a society of people who are incredibly tired, so we turn to caffeine.  However, as with any drug, caffeine drinkers build up a tolerance, requiring more and more to achieve the same results.  As well, there are withdrawal symptoms.  These can include headaches, irritability, difficulty concentrating and stomach aches (see more about this).  The only real solution to this aspect is more sleep.  Breaking caffeine addiction can be hard, but substituting it with a beverage such as water can result in some significant net health benefits.  By getting more sleep, you reduce your need for caffeine and at the same time benefit in overall health.

Few people view caffeine addiction with the same horror that they view an addiction to hard drugs, but considering that it can cost you thousands of dollars a year and cause a variety of health problems, it’s far from innocent.  Contemplate freeing yourself from your addiction to caffeine, your wallet will thank you.

Categories: Budgeting, Live Cheaper, Money, Psychology
Tags: addiction, caffeine, extreme aversion

For the Brain, Cash Is Good, Status Is Better

The article linked above has some very interesting results of a pair of tests researching which parts of our brains are concerned with earning or losing money and our reputations. The unexpected, and interesting, results of the studies revealed humans process making money and increasing our social status in the same area of the brain!

The area of the brain called the striatum had previously been identified as the brain’s monetary reward center. These new studies show the striatum is also where we process social values. This means having a good reputation affects our thinking in the same way as earning money. The studies further revealed that improving our reputation has priority over earning money in the straitum. So the answer to the title question of this post is that our brain functions to prefer status over money!

I can think of several ways this effect shows up in our lives:

• An improved job title will often satisfy us more than getting a raise. We want our reputation and job description to show our status in life and will forgo more money.
• A smart employer will understand that an employee’s status and reputation may have higher priority than actual income (within reason!). Employers should make sure employees are recognized in a public way for there contributions.
• This characteristic can be dangerous in our financial decision making. Are we electing to make or avoid a financial decision because of how we think it affects our reputation? Or how it will affect us financially? This can apply to many areas: buying a home, making an investment, choosing an advisor, and even making everyday purchases.
• This information may explain why we will pay significantly more money for similar items because of the brand or store.

Now that you are aware that your brain process your reputation and earning money in the same brain region, try to be cognizant of your financial decisions. Are you making them to improve or maintain your status, or to improve your net worth?

Categories: Investing, Money, Psychology
Tags:

The New York Times recently ran an article on the many ways that Americans are finding to cut costs in the current price-of-living increase we’re facing.

Spending data and interviews around the country show that middle- and working-class consumers are starting to switch from name brands to cheaper alternatives, to eat in instead of dining out and to fly at unusual hours to shave dollars off airfares…Retail sales figures and consumer surveys confirm that Americans are strategically cutting corners, whether it is at the coffee house or the airport.

If you’ve been feeling the pinch of $3.60-a-gallon gas and milk, you’re not alone; it’s happening to everyone, and people are acting on it instead of pretending it’s not there. They’re pinching pennies, cutting back on luxuries, doing for themselves rather than purchasing convenience.

Discounting worries over the economy and such, this is fantastic news for our brains. Consider: we don’t have to spend money we don’t have to look better than our neighbors. In fact, if our neighbors are pinching pennies, we may not even have to spend the money we have. The social pressure is easing off (for the working- and middle-class at least) to have the newest, shiniest things, and since relative wealth is the key to happiness, we don’t have to work so hard and buy so much.

Aside from a slackening in subconscious tension that comes from being in a race for social status, being able to look better than others with less money is a positive pleasure for the brain. Two studies recently published in the scientific journal Neuron found that the brain processes monetary and social rewards similarly. Keeping up with the Joneses (among other factors) has kept us as a nation from saving as much money as we otherwise might; now, knowing that the Joneses are letting their manicured lawn go dormant and their fashionable clothes go out of style will give your brain a double charge.

Categories: Economy, Psychology
Tags:

McMansions. That is the derogatory term that arose the last few years for the large cookie-cutter suburban subdivisions that seem to have sprung up everywhere. You may have driven through these subdivisions and, much like me, wondered where so many people found so much money. I know what I make. I know I’m in the top 5% or so of income earners. So why don’t I have a top 5% McMansion?

In retrospect, it has become obvious that many of these people could not afford what they bought. This leads to the question of why they bought houses that pushed the limits of what they could pay. Blame it on their brains.

It is a sad but true statement about the human race that we don’t care about absolute wealth. We care about relative wealth - how much wealth we have compared to other people. We don’t want a higher standard of living if everyone else has it too. Some books would say it is all a result of an elaborate mating game. Women and men, in an ever more intense race to impress each other, attempt to make it look as though their income and success are much higher than they really are. But it goes deeper than that. The problem with the housing market can be blamed on the ventral striatum.

Last year, the neuroeconomics lab at Bonn released the results of a study or reward that involved scanning the brains of participants. What they found was not just that brains responded well to a reward. They found that brains responded even stronger to a reward that was better than the reward given to others. The experiment involved pairs of male volunteers competing for prizes on the same task. The BBC article about the research explains it well.

Both “players” were asked to estimate the number of dots appearing on a screen. Providing the right answer earned a real financial reward between 30 (£22) and 120 (£86) euros. Each of the participants was told how their partners had performed and how much they were paid.

Using magnetic resonance tomographs, the researchers examined the volunteers’ blood circulation throughout the activities. High blood flow indicated that the nerve cells in the respective part of the brain were particularly active.

Neuroscientist Dr Bernd Weber explains: “One area in particular, the ventral striatum, is the region where part of what we call the ‘reward system’ is located. In this area, we observed an activation when the player completed his task correctly.”
A wrong answer, and no payment, resulted in a reduction in blood flow to the “reward region”. But the area “lit up” when volunteers earned money, and interestingly showed far more activity if a player received more than his partner.

This indicated that stimulation of the reward centre was not merely linked to individual success, but to the success of others.

You may have heard about “keeping up with the Joneses.” This research shows that it isn’t just something that affects a few of the more shallow among us. It is a real human need with a deeply rooted anatomical cause.

So back to the McMansions… what is a man to do… let all of his friends have the bigger, nicer, newer house? It seems that the drive of the ventral striatum outweighed the rational thought process for many people. All the while, lenders and investors, whose ventral striatums were firing like crazy as they tried to rack up larger earnings and returns, respectively, played along to satisfy that same deep seated need to be better than the next guy. The irony, or perhaps the karma, is that most of them ended up looking worse.

Categories: Mortgages, Psychology
Tags: brain, Debt, real estate