30 Aug Your Brain on Money
Here is a test for you: a bat and ball cost £1.10. The bat costs a £1 more than the ball. How much does the ball cost?
If you’re like most people, your answer would be that the ball cost 10p. That’s obvious, isn’t? But, it’s wrong. The correct answer is 5 pence for the ball and £1.05 for the bat.
If you got it wrong, don’t be too disheartened. More than half of students at Harvard and MIT of students at Harvard, MIT, and Princeton gave the intuitive—incorrect—answer.
Have you ever wondered why many smart people make poor decisions about money? For instance, when it comes to investing, everyone knows that we should buy low and sell high. Yet, people often do the exact opposite?
So, what happens inside your head when you think about money? And why is it that many smart people often make poor decisions about money?
Thanks to the relatively new field of Neuroeconomics, we have some answers. In the last few years, scientists have performed several brain scans on individuals to see how their brains respond to money.
The human brain is a very powerful organ! The grey matter in between our ears is the centre of decision making! The human brain is responsible for roughly 20% of our total calories burned each day, which is pretty amazing when you think about it.
There are two parts of your brain that make decisions — one is reflexive (instinctive and emotional) and one is conscious (more deliberate and logical). The reflexive system often responds before the conscious system realises it was supposed to respond.
Psychologist Daniel Kahneman describes these two parts of the brain as System 1 and System 2. System 1 is the brain’s fast, automatic, intuitive approach, while System 2 the mind’s slower, analytical mode where reason dominates.” Kahneman says System 1 is more influential, guiding and steering System 2 to a very large extent.
It is this System 1, the emotional part of our brain, that drives most of the decisions we make about money.
If your response was 10p for the ball, that’s your System 1 in action. It finds shortcuts to complete the task at hand. It’s quick and confident. Sadly, when it comes to managing our money, System 1 is often ill-suited for the task.
So what can we do about this? First, we need to be more self-aware when making decisions about money. Secondly, we can recognise the benefits of working with a competent professional who can help us make informed decisions about our finances.
Take your time, get advice, even if this means concluding what you have already decided. You may hear other options and together with your adviser you can be more sure that you have made the best decision for you.