Do you suffer from money delusions?
Posted
Jun 29 2009, 01:13 PM
by
Catherine Holahan
Rating:
Are human beings hard-wired for financial folly?
Yes, according to an article in this month's issue of Scientific American. Behavioral economists and scientific researchers interviewed by the magazine say human brains simply can't account for inflation.
According to the researchers, humans suffer from a biological flaw called "money illusion." To put it simply, our brains get excited when we receive large sums of money, even when prices have increased sufficiently to prevent any real gains in purchasing power. The human mind is simply fascinated by more money, even when it's not worth any more.
If you've followed the markets at all in the past year, you probably know this intuitively; people buy when it seems like everyone is buying and they sell when it seems like everyone is selling. We are motivated by fear, greed and, perhaps above all, group-think. It's in our DNA.
So how do we make sound financial decisions when our very brains may be conspiring against us?
Well, we can try to ignore the masses. Hedge fund investor Mark Spitznagel -- a protégé of "The Black Swan" author Nassim Nicholas Taleb -- made a fortune by following his mentor's advice and betting on volatility when most folks were betting that the market would continue to steadily march upward. We can also try to anticipate the "irrational" actions that certain news might spur and invest accordingly. We can force ourselves to behave in a contrarian fashion, learning to stomach the small losses that most people shy away from for emotional reasons in order to achieve larger gains down the road.
Or, we can rely on the government. Some recent regulations enacted by President Barack Obama and Congress are aimed at forcing people to behave more rationally with their finances. The new credit card law, in particular, aims to keep people from making poor decisions based on emotion. Just because we know intellectually that that new credit card's low interest rate is just an introductory offer doesn't mean, however, that everyone will be able to overcome the emotional allure of temporarily cheap cash.
As a last resort, we can try to short-circuit certain irrational parts of our brain. It seems there's a troublesome area behind our forehead that is easily stimulated by quantity over worth. However, no insurance plan -- or doctor for that matter -- is offering to cover or perform such a surgery. At least, not yet.
Take this quiz to find out how emotional an investor you really are.
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