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YOUR MONEY AND YOUR MIND: Neuro Economics Tackles How Our Brains Handle Money, Risk and Impulse Buys

Aired July 16, 2011 - 09:30   ET


CHRISTINE ROMANS, HOST: Why is it that smart people do dumb things with their money?

Welcome to a special edition of YOUR BOTTOM LINE: YOUR MONEY AND YOUR MIND. I'm Christine Romans.

We've all been there. Splurged on something we shouldn't have with money we couldn't afford to spend. Bought a stock high and then sold it low. So why can't we control ourselves? We'll get to that with our panel in a moment. But first a look at the complicated relationship between what goes on in here, when it comes to this.


UNIDENTIFIED MALE: It's Mega Millions.

ROMANS: The odds of you standing there with the big check are just north of zero. So, why do we buy a ticket?


ROMANS: Scott Hotel is part of Duke University's Neuro Economics Team, exploring among other things, why smart people make foolish decisions with their money.

SCOTT HUETTEL, DIRECTOR, CENTER FOR NEUROSCIENCE STUDIES, DUKE UNIV.: People don't buy a lottery ticket just because they have a chance of winning. They will buy a lottery ticket because over the next couple days it allows them to fantasize about what they would do if they won the lottery. In a sense they're paying for that experience, rather than for the chance of the lottery itself.

ROMANS: It's not just the lottery. Jason Zweig, author of :"Your Money & Your Brain", knows firsthand. He put his brain to the test with Scott's team at Duke.

JASON ZWEIG, AUTHOR, "YOUR MONEY & YOUR BRAIN": It's a combination of neuroscience and economics. Basically using the tools of scanning and other measurement technology that neuroscientists have used for years to study how the human brain evaluates risk and reward over time, which is what investing is all about.

ROMANS: From investing to buying a home, to why and how often we go on a spending spree. What researchers are learning is that when it comes to money, our brains are in some ways stuck in the Stone Age. ZWEIG: In modern life, if you lose your money, you've -- you may well have lost a lot more than-it's not just pieces of paper, you know, printed by a government somewhere. It's really -- it's the key to maintaining your lifestyle. It's safety. And you know, a million years ago, it would be the equivalent of losing your cave or losing your spear. Those are things that-

ROMANS: Or your dry wood.

ZWEIG: Or your dry wood.

Money is what stands between most of us and a completely different life, which is a much more dangerous life. I mean, one of the things we've learned in the past three years is that the loss of money, in a society, can have just disastrous consequences for millions of people, which a lot of Americans had forgotten. And so it makes perfect sense that the modern human brain would react to the loss of money the same way it reacts to the presence of a poisonous snake.

ROMANS: The brain is a big place, neurologically speaking. Where exactly do the alarms go off? We asked CNN's chief medical correspondent and practicing neurosurgeon Doctor Sanjay Gupta.

DR. SANJAY GUPTA, CNN CHIEF MEDICAL CORRESPONDENT: Now, the region of the brain we're talking about is something known as the Insula. Let me show you over here. This is a part of the brain that is largely responsible for negative emotion, like disgust, pain, the sensation you get that something is not quite right; that somehow danger is lurking in here. Some recent studies have shown the fear of losing everything, in this case your money, your livelihood could tap into that system and give you a real sense of fear.

ROMANS: But are all brains created equal when it comes to finances and risk taking?

HUETTEL: There's very strong evidence that there is no such thing as a single risk-seeking person. That is, someone who is risk seeking, for example, interpersonally, they like adrenaline sports, like to go sky diving. That same person might be overly conservative in their investments.

ROMANS: Through functional MRIs, hormone and genetic sampling, eye tracking and gaming simulations, neuro economic research is shedding light on this tug of war between the physiology and psychology inside our brains. When it comes to money and financial behavior, we're all still evolving, still battling our inner caveman.


ROMANS: No cavemen here. Jason Zweig is the author of "Your Money & Your Brain."

Jason, has the world become too complex, with its credit default swaps, and its complicated adjustable rate mortgages, for the way our brain perceives risk and reward in terms of money? ZWEIG: You know, I think it may well have, Christine. I think one thing that's is very important for consumers and investors to bear in mind, as they confront a world in which financial news is coming at us 24 hours a day, seven days a week nonstop, is the key question really is: Do I need to react to this? Because your natural instinct is to react to everything, to freak out about just about everything. Because your brain is a reactive mechanism and that's one of the protective aspects of the human brain is it's built to respond. And one of the keys, I think, to financial success in a complicated information overload world is to ask yourself, do I need to react. And the answer more often than not will be no.

ROMANS: Well, there's this joke on Wall Street, Sanjay, "Don't just do something, stand there." Because we like to think we make logical decisions, but sometimes we don't.

GUPTA: And it's funny if you sort of like look at the way the brain works, sort of building on what you're saying. The brain is reactionary but it is pretty much designed, as you say, in the Stone Age in terms of pattern recognition. I mean, you recognize patterns. You start to formulate simple decisions based on those patterns, and ultimately those simple decisions can be more complicated decisions.

What I find is interesting though as was said in the piece, it's very hard to pin point a personality, and say this is a risk-taking personality, or a risk-averse personality, because each situation comes differently to a person based on their memories, based on emotion. So, that skydiver, as was mentioned, could be very risk averse when it comes to their money because of the way their-you know, their hippocampus, the area of their memory works, and their emotions sort of layering into it.

ROMANS: That is on the quiz later, folks, hippocampus.

GUPTA: Remember it.

ROMANS: But you know, what's interesting, Sanjay, because it's the same brain that can be derailed by the adjustable rate mortgage or by a complicated credit default swap, that invented the iPad, the complicated mortgage and the credit default swaps, too. So the brain is so mysterious.

GUPTA: There's not as much novel thinking-and this is hard for me to say, as a neurosurgeon-but not as much novel thinking as we would like to believe in the brain. Again, I think it does come back to a lot of these patterns that people are sort of building on. So, while they do these complicated financial transactions-or dumb one, depending on what happens, and also invent these incredible new technologies, a lot of it is just simply building on existing knowledge. It goes back to that pattern recognition again.

ROMANS: Doug Hirschhorn is an investment psychology advisor. He trains traders at top financial institutions.

DOUG HIRSCHHORN, INVESTMENT PSYCHOLOGY ADVISER: Correct. ROMANS: It's always good to know the brain, and all of that. It seems our emotional side hijacks rationale thinking. Give us an example of where this happens.

HIRSCHHORN: It is a very common thing because people want to go for the simple stuff, but they are trading world where it's volatile. And you have to make quick decisions. They go for the simple information.

A great example I give to traders is that the market doesn't know if you're up or down money. So don't make your trading decisions based on information. We personalize things and then try to make a decision based on what our current status is. So, I'll give you a great way to think about it. If I told you had a 95 percent chance to winning in a game.


HIRSCHHORN: Would you play that game?

ROMANS: I would.

HIRSCHHORN: Most people will say yes, they would. Some successful traders say that. And I say, great, let's play the game. Every time you win, I'll give you a penny. Every time you lose, you give me $1,000.

ROMANS: OK, now that's a problem.

HIRSCHHORN: Now, that is exactly the point. You get caught up in the percentages. Get caught up in I like to win. It is an ego fulfillment as opposed to looking at the data of what's the odds of me being right, and how much will I make if I'm right or wrong.

ROMANS: The brain is pushing us The way the brain is, it is pushing us to go for the win.


ROMANS: All right. Gentlemen, leave it there.

We know the forces that play in our minds. Next, how do we take that knowledge and make better decisions about our money in all aspects of our life?


ROMANS: When it comes to investing, we know we're supposed to be rationale and objective, but often our behavior is anything but that, as we saw last May.


ROMANS (voice over): Panic selling. The flash crash of May 6th, 2010. The Dow plunges nearly 10 percent in less than 30 minutes; the panic leading to a suspension of logic. (On camera): Rationally, it was clear that something was amiss, something was going on.

ZWEIG: The human brain really does not like surprise. The reason the flash crash was so devastating is because it was so explicable. It caught people completely by surprise.

UNIDENTIFIED FEMALE: If you choose to gamble, you have a 50/50 shot of keeping all 40, or losing all, so you just get zero.


ROMANS (voice over): It's this type of risk and reward scenario that neuroscientists like Scott Huettel and the team at Duke University hope to better understand by conducting experiments with real money.

(On camera): This is called a functional MRI. And what does it have to do with how we save our money, how we spend our money? How we risk our money? Everything, because it shows what's happening right up here.

(Voice over): In the MRI, volunteers are presented with different choices, keep a small amount, or risk it to win more. By changing the dollar amounts at risk and the dollar amounts that can be gained, scientists are able it see how different areas of the brain react as decisions are made.

HUETTEL: There's an area we're very interested. It's called dorsal medial pre-frontal cortex. That is a fancy way of saying the area that is in the middle, top and front of your brain. That part of the brain seems to act almost like a switch in a train yard. Or it's telling all the other parts of the brain that might contribute to a decision which ones are going to be active at any moment in time. What it does is it seems to switch between say a more risk averse and a risk-seeking mode, depending on what's going on in the task at any moment in time.

UNIDENTIFIED FEMALE: 140 and, one, two, three, four. OK? Now that's it for today. That's your win for today. Thank you.


UNIDENTIFIED FEMALE: That was a great winning.

ROMANS: So imaging technology can tell you a lot about what your brain is doing, how you're thinking and feeling about spending your money. That's pretty hi-tech. There's also a pretty low tech way.

When the person goes in the MRI they are giving you a saliva sample. And the saliva is going into something like this.


ROMANS: It is just a tube like this holding their saliva. STANTON: A simple tube.

ROMANS: What do they find? What do you find in this simple tube? What does it tell you about what somebody's brain is thinking, or doing about money or risk?

STANTON: The way that we use this is we take individual saliva samples and through a test that's been available for the last 40 years, we can measure things like aspects of their DNA, we can measure hormones like testosterone, or the stress hormone cortisol. So through the MRI, we can look at interactions between your physiology. So, something like testosterone or cortisol, and your brain activity when you're processing some of the gambles we have people do in the scanner.

ROMANS: Interesting. So, it' not just the picture of the brain. It's the picture of the brain you're taking, and what you're finding in the saliva, the hormones and other things that are taking an entire picture of what somebody is doing financially, with risk and reward?

STANTON: That's right. Because really the thing we're growing to understand in these interdisciplinary fields, something like neuro economics where you're combing the field of neuroscience and behavioral economics, is that our decisions are influenced at multiple levels. So we can try to study behavior by itself, we can try to study the brain by itself, but the more you account for all aspects of both behavior and physiology and neuroscience I think that's going to continue to let us you know, more completely understand our behavior.


ROMANS: It's really interesting stuff.

Jason, given what we know about hormones, brain makeup and emotions, what's the number one mistake investor make? Because you know what, we buy high and sell low. We do it all the time.

ZWEIG: It's performance chasing, Christine. It's investing as if you were driving a car only by looking through the rearview mirror. You know, people, the more a stock goes up, the more people want to buy it, even though none of us would buy socks the way we buy stock, right?


I mean, if Wal-Mart raised the price of socks 50 percent, you wouldn't say oh, I want to buy more socks. You would say I'll wait till the price comes back down. But when it's stocks instead of socks, people love it.

ROMANS: Help me beat my brain. Help me not do that. Help all of us, what can we do to try to-let's say override that wiring? I know it's not exactly a good metaphor. How do we do it?

ZWEIG: What you need is policies and procedures. You have to have a plan in place and you have to live by the plan. So you can write what's called an investment policy statement that allocates your money across different assets. And sets conditions under which you will trade, or you won't trade. And you can have a simple rule that says, I will never buy an investment purely because it's gone up in price. I have to have at least three reasons that have nothing to do with recent price change.

ROMANS: All right. Jason Zweig. Very good advice and you wrote the book on this stuff.

ZWEIG: Thanks, Christine.

ROMANS: All right. Stick around, everybody. Next, who are the biggest risk takers and why? Is it all about nature versus nurture?



ROMANS (On camera): See, you took a big gamble and you got that.

I mean, I would have taken the other one for sure.



ROMANS: Yes, that kid was riskier than I am. That took place in Elizabeth Brandon's laboratory at Duke University, where they found, perhaps not surprisingly, that kids are more risk prone and people become more risk averse as they get older. Interestingly, the brain scans of kids that are less willing to gamble actually resemble adult brains.

Sanjay, how much of this is actual brain development? How much is nature versus nurture? Are we wired one way, or are we wired and then we are raised a certain way?

GUPTA: Well, you know, wiring is sort of a loose term.

ROMANS: Right.

GUPTA: When it comes to the brain because it can change certainly over time and based on your experiences. I think, loosely speaking, when it comes to the nature part, the frontal lobes, the area of the brain that is sort of responsible for our ability to have good judgment, to be less impulsive, those develop more as you get older.

I mean, there are some people who say, people shouldn't drive until they are in their 20s, for this very reason. I mean, having teenagers drive might be too early. But they also may become less likely to take risks or a little bit more risk averse, as you say, as a result of those frontal lobe changes.

But the nurture part of it, I think, is more interesting in some ways and maybe even a bigger factor. Your emotions, your memories of past experiences, and how those all layer in. Despite how well- developed your frontal lobe is, it can start to resemble someone who is younger based on your impulsivity and the changes that are happening.

ROMANS: And Doug, there's age, and there's also gender. Women and men do differently on some of these tests.

HIRSCHHORN: Yes, there's been research over the years that looked at investment profiles of men and women. But I find as an applied practitioner working with the traders.

ROMANS: Right?

HIRSCHHORN: There are very, very few women on Wall Street. And what I find remarkable is that as a coach to top traders, I have to deconstruct male things, ego orientations and layer in self-awareness. The funny example I use for clients is, before GPS existed, right? If a guy is driving around in a car and gets lost, he will not stop and ask for directions. He takes it personal. He wants to find his way. A woman will say, I would stop for directions, it would be stupid not to. So women are more reflective when things go wrong. Men want to trade for revenge and get back to avenge themselves.

ROMANS: So maybe women should be better traders. There should be more and more women on Wall Street.

HIRSCHHORN: I've been saying-I believe actually it is not about gender equity for me. It's about performance. I believe there should be more women than men trading on Wall Street.

ROMANS: Who's the risk seekers, Jason? Is there a profile of a risk seeker?

ZWEIG: I don't really think so, Christine. I think one thing that all investors and consumers, for that matter, should bear in mind is that risk is as much a product of the situation as it is of your disposition. So you take a person who is not generally considered a risk seeker, you put that person in a risk-seeking situation. And their behavior may change completely. Also, perception is very sensitive in changes, so rapidly. Think about how people felt after September 11th.

ROMANS: Right.

ZWEIG: Or how people in Japan are probably feeling now. The slightest little risk is enough to really get people disturbed. And, you know, you're almost like a -- it's as if you're bruised all over and anything that touches you hurts.

ROMANS: And that's perception and perspective, but that all is happening here in the brain.

Gentleman, stick with me. We've all heard that money can't buy you happiness, but if you've ever bought something on impulse, you know the high you get. What happens inside your brain at that very moment? The answer might surprise you. (COMMERCIAL BREAK)

ROMANS: One of the things we learned at Duke University, our happiness is somewhat set, and while earning or losing money can make it go up or down, it's not a long-lasting effect.

Sanjay, we get a temporary high from buying an expensive pair of shoes, for example. It's been compared to actually taking a hit if you're a drug addict. Why do we get a rush from spending money?

GUPTA: There's a couple of things that are happening, that are interesting. One is, this might be surprising, but it's more in some ways the anticipation of actually buying something. So the idea that you, as was said in your piece, of fantasizing about those nice new shoes that you might have, or a new gadget or something like that.

ROMANS: It's the journey, not the destination?

GUPTA: In some ways, it is. In fact, to take that one step further. Actually getting the shoes, or whatever it may be, may seem like a little bit of a letdown, because the reward system in your brain, that changes. And there is a reward system in the brain. It's a little bit of a diffuse area, but let me show you.

We're looking at the inside of the brain. There's a few structures, sort of along the midline here. I'll just say the names. You don't need to remember these but the nucleus accumbens, is a really important part of your brain when it comes to your reward. More neuro transmitters fire there, you feel good. But as you said, that's a short-term thing. It's hard to think of happiness as chemical. You know, literally neuro transmitters, but it is. And those neurotransmitters start to go away after a while. So emotion, as a chemical, is true.

ROMANS: And it explains what millions of people already know. They went out, they bought the thing, and then there was the letdown.

GUPTA: That's right.

ROMANS: The impulse buy was not worth the impulse, but you cannot stop yourself.

GUPTA: That's right. And we think of that psychologically, oh, maybe it wasn't as good a pair of shoes as I thought they were going to be, or whatever.

ROMANS: It's not the shoes, it's in your head.

GRANT: Yes, something truly is happening. Those dopamine levels systems may start to drop, the reward system isn't as bright anymore. And that letdown is almost predictable.

ROMANS: Dough, you say from an investing perspective, that losses have a bigger impact than gains?

HIRSCHHORN: Right. For traders, it's more about the process, the experience. There was research done a long time ago-not that long-but it showed that the average person losing a dollar felt some degree of bad, and you had to make $2.50 to offset that balance. So what I find with trades is they get a rush actually from the process. But actually losing money is actually more of an adrenaline rush to them, than it is making money. And as a result, they push themselves to strive to make more money and offset it. Again, the emotion is about the dollars and it makes them have a skewed perception about what they are doing.

ROMANS: I mean, I think you can see that outside of the trading world. I think that's something that holds true for consumers and others. You're so worried about losing. Also, you talked about gender earlier. Women, a lot of studies show that women are much more afraid of losing money than men are.

Jason, we see how the brain works. But there's a psychological effect here as well. I participated in an experiment looking at how we value things. Whether it's stocks or iPods, or shoes. Are we really -- what are we buying into? Are we buying into status, acceptance? What is it?

ZWEIG: Well, I mean, reward is definitely social, Christine, for most of us. We don't live on a desert island, we don't live in the middle of, you know, the Sahara or something. We live among our peers. And we compare ourselves to other people all the time.

Unfortunately, what with I think all too many, especially American consumers, get caught up in is the notion, if I just had one more X whatever X, is, an iPad, you name it, a big car, then I would feel happy. It's not how much money you have that really determines your happiness, it's how you spend the money you have. And if you spend money on social experiences, bringing yourself together with friends and family to create new memories that you can look back on later, you really will optimize your happiness with your money.

ROMANS: But don't you think that advertisers and the whole way the consumer world works are all geared to try to get us to part with our money, to try to play into those impulses. Because those impulses are real and they're deep-seated.

ZWEIG: Yes, absolutely. And one of the best things you can do is you can schedule ahead. You can say, I'm going to plan a family reunion for next June, or something. And you put it ahead, you mark it on your forward calendar, and that way you prevent yourself from getting sidetracked from creating that positive experience.

ROMANS: Gentleman, this has been a fascinating half hour. Sanjay Gupta, thank you so much, Jason Zweig, and Doug Hirschhorn, gentleman, it's been a pleasure.

ZWEIG: Thanks.

ROMANS: That's going to wrap things up for us.

Send us an e-mail to YOURBOTTOMLINE@cnn.com or you can find me at Facebook and Twitter @christineromans. Thanks for joining us for this special edition of YOUR BOTTOM LINE. Back now to "CNN SATURDAY MORNING" and a check of your top stories making news right now.