Old Brain vs. New Brain: The Impact of Impulse on Financial Decision-Making

Could mood-based impulses inherited from our early human ancestors threaten not only our stock portfolios but the future of sustainable finance?

If you want to help protect the planet for future generations, investing in sustainability is a smart idea. But a new study has found that our prehistoric "old brain" instinct to reproduce can thwart our reasoning skills when it comes to making financial decisions.

SO MANY SMART THINGS TO DO...

Since the financial crisis gripped the world's collective psyche in 2008, the search for sustainable economic solutions has given rise to much chatter about "the smart thing to do."

After a roundtable meeting with labor and business leaders in Alexandria, Virginia, in December 2009 -- the end of a year that saw the first decline in global production since World War II[1] -- President Obama said that investing in energy efficiency doesn't just create jobs, but is "a smart thing to do."[2]

In March, retired Supreme Court justice Sandra Day O'Connor and Kim Azzarelli, the co-founder and chair of the Avon Global Center for Women and Justice, argued in a Cornell International Law Journal paper entitled "Sustainable Development, Rule of Law, and the Impact of Women Judges" that investing in women should be viewed "not only as the right thing to do, but the smart thing to do."[3]

Last month, Christian Wells, director of the office of sustainability and deputy director of the Patel School of Global Sustainability at the University of South Florida, said, "We are at a unique time in human history, where the right thing to do -- investing in sustainable business solutions -- is also the economically smart thing to do."[4]

...BUT SO MANY FAILURES OF RATIONALITY

But just because there are many sustainable investment opportunities doesn't mean that they're being taken. After all, part of the reason we're in crisis mode on several fronts is because the tenets of sustainability, particularly in the realm of finance and economics, have been neglected.

Presenting research from the growing field of behavioral finance, a Barclay's Wealth study released in June found that wealthy individuals who made financial decisions based on emotion rather than reason lost up to 20 percent of their investment returns over a 10-year period. The authors noted, "One of the difficulties we have as investors is what we might call 'failures of rationality,' which makes it very difficult for investors to do the right thing."[5]

LOVE AND LOSS (AVERSION)

Now, according to a study published online last month by the American Psychological Association and led by Douglas Kenrick, Senior Sustainability Scientist at the Global Institute of Sustainability and a professor psychology at Arizona State University, it appears that there's a reason for all this unreasonable decision-making, and it has to do with evolution. Kenrick found that the phenomenon of "loss aversion" -- a preference to avoid losses over acquiring gains -- is dependent on one's state of mind and motivation at any given moment.

In one experiment, study participants were asked to rate their level of happiness or unhappiness in two situations: lose $100 or get a 30-percent boost in financial assets. As in past studies, the loss was weighed more heavily than the gain. But Kenrick's team uncovered something that bucks this trend: Men became less loss averse (i.e, more willing to experience a financial loss) when mating was on their minds (i.e., after imagining romantic encounters). Conversely, women in a similar mental state became more loss averse financially, confirming the assertion that evolutionarily speaking, the decision to mate has costlier repercussions for females, due to pregnancy and nursing.[6]

SUSTAINABLE FINANCE, MEET BEHAVIORAL ECONOMICS

Kenrick and his colleagues have also done related research that has demonstrated that women -- but not men -- prioritize potential mates by their relative position in the hierarchy of dominance, a situation in which he says, "men need to be willing to take some chances to win mates." Kenrick added, "From an evolutionary perspective, loss aversion isn't always a good thing. Worrying about losses could certainly have helped our ancestors deal with threats, but it would not have helped men win the mating game."[7]

To be sure, winning is not always just the result of applied logic, but often partially born out of instinct, luck and a little bit of daring, a mix that necessarily involves an emotional dimension. And perhaps because reason has proven to be such a fickle mistress, particularly when it comes to making financial decisions, we can safely assume that unanticipated market fluctuations will continue for a long time, a condition that challenges the drive toward "sustained stability," a main theme at last month's UNEP FI Global Roundtable.

I'M IN THE MOOD FOR...SUSTAINABILITY

"These new findings are controversial," Kenrick said, "because they contradict the assumption that economic decisions in the modern world are determined at the conscious level. Instead, it seems that biases our ancestors developed millions of years ago affect decisions we make today -- in ways that influence our finances for years to come."[8]

As Mr. Wells said, "We are at a unique time in human history." But actually, we are living at a unique time in the Earth's history: the anthropocene, the first geological time period in which a single species has influenced the planetary environment. It began with the Industrial Revolution, when humans started pumping carbon dioxide and other global warming gases into the atmosphere.

For us and Earth's other species to survive in the long run, the concept of sustained stability must be transformed from a utopian ideal to a reality. And insofar as sustainable investing is a part of the overall solution, making financial decisions should probably be avoided when you're in the mood for love.

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