High-Stakes Decision Making: How Neuroscience Rescues Behavioral Finance
This year, the 2017 Financial Analysts Seminar will be held in Chicago on 24–27 July. Learn more about the agenda and speaker details on our website.
Behavioral finance frequently makes investment managers giggle more than it makes them grateful. After all, it is comforting and simultaneously humorous to know that your investment mistakes have a reason behind them. Yet behavioral finance offers few prescriptions for how to combat the cognitive errors that it so adroitly points out, leaving many ungrateful for having their foolishness pointed out to them.
Enter neuroscience — and in particular, the work of folks like the University of Chicago’s Sian Beilock, a speaker at the 2013 Financial Analysts Seminar in Chicago. Beilock is the author of Choke: What the Secrets of the Brain Reveal about Getting It Right When You Have To, which was expressly written to provide solutions for the harried professional who must make high-stakes decisions under pressure.
Beilock highlights an internal battle within the brain between the structured focus of the prefrontal cortex and the frequent emotional subterfuge of the amygdala. When stakes are high, the amygdala bombards the prefrontal cortex with emotional and physical content, reducing the ability of the prefrontal cortex to operate. Argh!
In particular, there are three kinds of problems normally encountered by high-stakes decision makers:
- In high-stakes decisions, people frequently pay too much attention to the multitude of details involved in a decision. Simplicity fades in favor of complexity. This problem is commonly known as “analysis paralysis.”
- Duress decisions are often robotic and mechanical. Creativity is turned off.
- Emotional tsunamis frequently overwhelm the careful plans and analysis of investors.
Fortunately, for each of these problems there are ready-made, proven solutions. Curious? Thought so.
Overcoming Analysis Paralysis
To overcome analysis paralysis, you need to refocus the prefrontal cortex. How? By concentrating on one outcome as opposed to many. In her session, Beilock offered a golfing example: Rather than focusing on the endless details of the perfect shot — such as the correct club, proper grip, turning your shoulders just so, and so on — focus instead on the single outcome: where you want to put the shot.
You may be thinking: What if I mess up one of the pertinent details? Professionals frequently possess the skill set necessary to make their decisions — the intellectual equivalent of muscle memory — but they obsess over technicalities. Instead, try trusting your years of education and experience and just focus on the outcome you desire.
Reigniting Creativity to Solve a Problem
We have all been there before . . . a vexing problem confronts us: How do I value that illiquid security? How do I position my portfolio for the next macro event coming out of Europe? What do I do when interest rates rise? And we obsess over a solution. Yet none is forthcoming.
In such a situation, Beilock recommends that we walk away from the problem confronting us and do something else. This could be virtually anything, so long as the problem is not front and center in your cognition. Neuroscience is overwhelmed with supporting data that shows that minds work on creative solutions deep outside of consciousness and that answers frequently appear as if by magic when we are doing another activity.
What if you don’t have the option of taking the time to not think about the problem? Beilock recommends that you engage in conversation with someone else about the problem. Very importantly, this does not have to be another expert on the subject. Just by talking about the issue with someone — anyone — solutions frequently appear out of nowhere.
Regaining Composure in the Presence of Emotional Turmoil
You say to yourself, “When the market was like this last time, I lost 112 basis points and went from top decile to the top quarter. I don’t want that to happen again!” Here you are focused on a previous negative outcome, and it detrimentally affects your cognitive abilities. What can you do?
Try focusing your attention on the previous and painful event and objectively identify one thing that you did wrong. Next, force yourself to consider what you can do to change it. This simple process provides a wedge for you to intercede in the emotional avalanche. From there, you can carve out the breathing room you need to learn from your mistake and move on.
Additional Tips for Better High-Stakes Decision Making
- Meditate. Beilock recommended that high-stakes decision makers meditate, given that study after study after study has demonstrated that it leads to better decision making and greater clarity of thinking. In particular, the benefits accrue when folks meditate for 11 hours each month. Those who do so show an increase in the functioning of their prefrontal cortexes.
- Walk in nature. Leaving the office and taking a walk in a natural setting enables your prefrontal cortex to rejuvenate itself. Unfortunately, when you walk through a city the effect is not nearly the same. “Great,” you may say, “I work in [New York, London, Hong Kong, Singapore], the closest nature is not that close!” No problem. Research demonstrates that even looking at pictures of nature can help you recover cognitive abilities.
- Closing the gap between training and performance/competition. Beilock recommends that you simulate the stresses that you experience in the real world. In other words, try and create a “war game” of what you are likely to encounter in a stressful situation. The more frequently you engage in these stressful (yet artificial) situations, the better your decision making becomes as the prefrontal cortex and amygdala acclimate to the situation gamed.
These solutions are not panaceas, but they are powerful and proven techniques to help you make better high-stakes decisions. Let’s be careful out there!
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
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