Leaving emotion out of financial decisions
 |
Frank Ashe |
Research in behavioural finance suggests that short term and long term financial decisions are made with entirely different parts of the brain.
Dr Frank Ashe from Macquarie University’s Applied Finance Centre has a major interest in the area of behavioural finance, which looks at how our basic brain structure affects the financial decisions we make.
He says the part of the brain that humans have in common with reptiles and birds needs to be ignored when making financial decisions.
“When people are making short term decisions, the part of the brain which is working is the one that retains links to really ancient lineages - the lizard part of the brain,” explains Ashe. “When we make long term decisions we use the part that is unique to humans, the rational part of the brain.”
Neuro-economics
In recent times behavioural finance has moved into the area known as neuro-economics where people’s brains are scanned to see which part lights up when a particular decision is being made.
“When we put people inside a functional magnetic resonance imaging machine, it shows that different parts of the brain light up when people are making either a short term or a long term decision,” says Ashe. “When we are making a short term decision, the part of our brain that lights up is linked with our emotions. We can be easily swayed by an emotional argument in a short term decision but in a long term decision we are able to overcome it in a rational way.”
How to stop investors behaving badly
There are a number of techniques that can be used to try and stop investors behaving badly according to Ashe.
“A misunderstanding about a lot of economics is that if we give people more choice it has to be better for them,” explains Ashe. “This is fine if we only ever use the rational parts of our brain, but we are going to succumb to temptation when a short term decision is to be made. What we need to do is observe our behaviour and by doing this we are going to cut down the number of irrational decisions we make.”
Investors should regularly evaluate their achievements and their catastrophes to work out the processes they used to get there. Ashe also advises seeking out a wide range of opinions, including some which are contrary to your own.
Never make a short term decision
Ashe recommends that investors never make a short term decision. “Always make a decision with a long term perspective,” says Ashe. “When you make a decision ensure that it has the minimum amount of emotional impact. If you feel there is some emotion attached don’t make the decision immediately – leave it for a day or two.”
Macquarie’s Applied Finance Centre offers short courses in behavioural finance and neuro-economics. For further information visit www.mafc.mq.edu.au or contact Dr Frank Ashe frank.ashe@mq.edu.au