Anchor and Adjustment

I am slowly making my way through Jason Zweig’s book Your Money & Your Brain which is credited as being one of the books that brought the topic of neuroeconomics into the mainstream.  I have been fascinated with some of the concepts and experiments that Zweig outlines in this book.  One of these concepts he calls ‘anchor & adjustment’ and is used to describe the process by which our brains operate in terms of coming up with estimates for answers we may not be certain about.

He gives the example of asking how old John F. Kennedy would be today if he were alive.  Go ahead and ask yourself that question.

If you’re like most people you might think 75-80 at first and then after taking longer to ponder the question adjust your answer higher to 85-90.  The truth is that JFK was born 05/29/1917.

When our brains are posed with a question and we are not certain about then our intuition “anchors” our initial guess.  This emotional response will typically be influenced by our previous experiences and memories (think of JFK’s youthful face).  However, with time, the rational part of our brain enters the estimation process and begins to use reason in determining our final guess.  Zweig calls this process the “adjustment” phase.  This is when most people begin to increase their guess of JFK’s age today.  However, because our initial guess was “anchored” in our emotional response by the time our rational brain takes over it is difficult to “adjust” our answer high enough to compensate for the initial anchor.  As a result, our final estimate is somewhere between the correct answer and our “anchor”.

For trivial matters like the aforementioned JFK question it may not make much of a difference.  However, in the financial planning process this is important to understand.  For example, if a household is estimating the return on their investment savings/ inflation and their assumptions are influenced by this process then the initial estimates could be far from reality causing them to under-save or over-save during their lifetime.

This process is biological in nature and impossible to reverse (without millions of more years of evolution).  Having said that, if we are aware of this process we can consider the impact that our emotions have on our ability to estimate things in our lives (including financial figures).

Zweig’s “Your Money & Your Brain”-Post #1

I’ve blogged a few times in the previous months about my recent fascination with the subject of “neuroeconomics”.  This is a field of study that looks at the role a person’s pschye, emotions, and/or subjective-self plays in making economic decisions.  I’m fascinated by this subject because of the gap between the body of fiscal knowledge that is readily available to households and the widespread lack of financial health.  I used to believe that the primary reason for this gap was a lack of significant fiscal curriculum in our schools.  The idea being that people were never taught how to properly manage their finances and therefore didn’t practice healthy habits.  I still believe that our society could benefit from better education but I now recognize that the issue isn’t necessarily knowledge-based.

The reality is that most households know they should spend less than they make so that they can save for future needs (i.e. retirement, rainy day fund, etc.).  Furthermore, most households have a desire to put their financial lives in order.  The problem is not knowledge it is pschological.  As Jason Zweig points out in his book “Your Money & Your Brain” the human brain has evolved over millions of years and only in very recent history has it been exposed to rational, analytical reasoning.  It’s no wonder that despite our understanding of concepts it is still very difficult for us to put theory into practice.  Here is an excerpt:

…our investing brains often drive us to do things that make no logical sense-but make perfect emotional sense….Our brains were originally designed to get more of whatever would improve our odds of survival and to avoid whatever would worsen the odds.  Emotional circuits deep in our brains make us instinctively crave whatever feels likely to be rewarding- and shun whatever seems liable to be risky….That’s why knowing the right answer, and doing the right thing, are very different.

I look forward to completing this book and gaining a greater understanding of the biology of how decisions are made.  I plan to share other thoughts and excerpts over the course of the next few weeks so please stay tuned.  If you have any interesting thoughts or resources to share on this subject please do so below in the comment section.

The emotion of financial decision making

I’ve recently become very interested in the field of neuroeconomics.  The word “neuroeconomics” is a scientific-sounding word that basically describes the field of psychology that studies how we make decisions about money.  The reason I find this so interesting is because as a financial professional and educator I am always dumbfounded when I see people make poor financial decisions (including myself) even though they know better.  For example, everyone knows that they need to spend less than they make yet for a few months in 2006 households collectively in the United States were spending more than they made.  Even grade school students know this isn’t wise yet again and again households find themselves in difficult financial circumstances.  But why?  For the longest time I blamed the lack of a comprehensive financial curriculum in our school systems but after reading into the field of neuroeconomics I’m beginning to think that emotion has more to do with it than lack of education.

So, I’ve added a category to devote to this topic and plan to write more about it in the future.  If you have any experiences or resources that you’d like share please comment below.