Neuroeconomics

I read about an emerging field today called "neuroeconomics." This means doing fMRIs on people as they make decisions involving money, greed, and risk. (fMRI = functional MRI. It allows real-time viewing of blood flows in the brain. It could veyr quietly revolutionize both medicine and psychology).

Anyway, they found that people use their "rational" centers (like the pre-frontal cortex) to think about long-term money matters, like buying mutual funds and making savings plans for retirement. But when making decisions in the here-and-now-- like whether to have that third helping of coconut-cream pie-- it was pure animal brain. The rational centers were overwhelmed. This is why people make stupid buying decisions on the spur of the moment.

Guess who makes the most spur-of-the-moment buying decisions? Traders on the floors of the world's major stock exchanges. Economics is not rational. People are not rational. It's only a matter of time before standard economic theory, based on the "rational actor", is jettisoned in favor of more psychologically sound (and mathematically messy) models.

I noticed a neat personal connection too. I just saw my financial adviser the other day-- it's a once-a-year thing. Anyway, at some point I had to take a "risk profile" test, where I answered a bunch of questions about what I would do in various hypothetical situations.

They were all in-the-moment situations, like "would you rather place a bet that has a 50% chance of getting you $100, or one with a 25% chance of getting you $200 and a 25% chance of losing you $25." Or whatever.

Anyway, on that test, I came out "moderately risky." This means that my adviser is constantly offering me investments based on a "Moderate" portfolio. Such portfolios have a mix of stocks and bonds. But this makes no sense for me as an investor. I am young enough that my portfolio should basically be all stocks.

Everytime I tell her this, she says, "Yeah, but you came out Moderate on the test...."

Well, of course I did. That's how I am in short-term situations. But for long-term investments, I can use my rational brain and say, "In the long term, I need to have as much as risk as possible in my investments in order to gain the highest possible returns. I am young enough that this makes sense."

So I can rationally choose to be much less rational than I would be in the short run, even though it is the animal brain working in the short run.

Neuroeconomics might just have something to it...