Fear and loathe the stock market? That’s your amygdala

Love your amygdala. A recent study of people with lesions on this important brain structure showed that amygdala damage makes us less risk averse (i.e. riskier), especially in financial decision-making. Avoiding risk is one of the cornerstones of human neurological functioning, so it is in our best interest to keep our amygdala healthy. Luckily, lesions on this structure are rare. Alexithymia (that’s alexi-THY-mia), or a deficiency in processing emotion, is also associated with decreased risk aversion. People exhibiting alexithymia are inclined to gamble with more money than people with unimpaired emotional processing, so not only do they make risky bets, they also bet big. It does make sense that those who can’t understand their own emotions might be freer with their cash, since people do need to be able to evaluate how they feel about a loss in order to learn to avoid risk. As University of Iowa’s Antoine Bechara, a neurologist, says, “Regularly evaluating whether an outcome made you feel good or bad will help you learn from your behavior.”

What can we learn from this? Fear learning and emotional processing, both of which are linked to the amygdala, are beneficial to avoiding risk. But finances are not as simple as the decisions the  amygdala evolved to address. In a complex financial world, our brains’ defensive “gut instinct” rarely leads to optimal investment outcomes.

As you are reading this, you are probably thinking to yourself, “Hey, if my brain wants to be risk adverse, that’s probably a good thing overall.”  But, you are only thinking of risk in terms of losses – the brain also fears missed gains. On the one hand, you can have the fear of loss, which causes people to sell out near the bottom of a stock market crash. On the other, you have the fear of missing out, like when a person dumps money into an over-bought stock market with the expectation that stocks will keep rising.

Much like the effect of stress discussed in an adjacent article, fear tends to push us to investing extremes – either extreme conservatism or extreme risk. This is precisely why, at Community Ladders, we use diversified investment strategies that aren’t subject to buying and selling based on emotions.

References and Suggested Reading:

CNN Money – A good, short primer on your brain and investing

Financial Planning Association – A bit more in-depth look at your brain on investments.

And, if you miss your college psych class:

Bibby and Ferguson, 2011, in Personality and Individual Differences, Vol. 51.;

Martino et al., 2009, in PNAS, Vol 107, No. 8.

Joe Grammer works in a suicide prevention research lab at the National Naval Medical Base. At Community Ladders, he writes about psychology and how it relates to finance and consumer choices.