Our brain has a very complex relationship with money. From a purely economic perspective it really should be simple – money is a tool that’s used to get something done, no different to a shovel or a hammer.
But while the mathematics of economics may be coldly rational, our brain is not. The human brain is a biological filter, through which cash becomes more than an emotionless inanimate bit of paper with a number printed on it. And now thanks to a recent study we can see exactly how thinking about money changes the way brain works.

Pay cut or pay rise?

The revealing work published in PNAS this month, examines what happens in our brain when we experience the so called “money illusion”. In a nutshell this is where we see an increase in income as a positive thing even when costs go up by the same amount.

Let’s take a less abstract look at this by using a common thought experiment to demonstrate the illusion:

Let’s say your income goes up by 2% but inflation rises by 4% at the same time, completely negating the increase. Would you rather take a 2% pay cut and have the price of things remain the same, or take the 2% salary increase with 4% inflation? Clearly both things are the same so it doesn’t matter what you choose. But when we ask this question to large numbers of people the majority always choose the salary increase. But if it makes no difference, why is there a bias?

Economists have often been skeptical of the existence of the money illusion. The purchasing power of cash in the inflated financial example above has not changed, and people aren’t stupid they are aware of what is going on. A rational mind is right to see no change. But what do you know, the human mind is not a completely rational place. But skepticism of the money illusion was well founded, since other than question based surveys there really hasn’t been a lot of hard evidence to pin down why this illusion exists. Until now.

Big winners are big grinners

The subjects of the study were asked to solve a series of simple problems and were rewarded monetarily based on how well they performed. At the end of the test everyone had to spend their money by picking items they liked from a catalogue of goods ranging from CDs to computer accessories. The whole time they did this the researchers monitored their brain activity by fMRI.

The twist in this simple exercise comes when the experimenters tweaked this arrangement by getting subjects to do this whole process twice: The first time the cash rewards were small, and the cost of the catalogue items were also low. The second time around the cash prizes were doubled and the cost of the items in the catalogue were also twice as expensive.

Obviously there is no difference in how much purchasing power the money has between the two experiments, all the subjects knew this, and yet there was still a striking difference in the neuronal activity between experiments.
One region of the brain (the ventro-medial prefrontal cortex) had much higher levels of activity only when the numerical value of the cash prize was higher. And wouldn’t you know it, this region of the brain has been previously been associated with sensations of elation and joy in response to pleasurable experiences. Big numbers bring big joy it seems. David DiSalvo also has a good write up of this effect here.

Inflated consequences

This confirmation that the money illusion actually exists turns out to be pretty important. It explains for example, why the economy can be re-flated by liberal financial policies. It’s also probably a factor that explains why nominal salaries rarely fall, whereas the actual value of your salary in does drop in value during periods of inflation.

But this is just the tip of the economic iceberg, the effect of our irrational perception of money can go way beyond how much you think you get paid.

Take for example the housing market. It’s not breaking news to say that property prices rose quickly in the last few years and was followed by the current devastating bust. The money illusion can easily contribute to muddying understanding between the nominal and actual value of mortgage interest rates.

It seems like a logical thing that when inflation is low, the monthly nominal interest payments on mortgages are low compared to the rent of a similar property.
So property prices now appear to be cheap. People, for whom the money illusion is a factor, are now likely to buy instead of rent, which produces an upward trend on house prices when inflation declines. But when inflation decreases it also increases the “real” cost of mortgage payments in the future.

This is an example of how the money illusion can act irrationally with people basing their purchase decision on the current low nominal mortgage payments while failing to accurately asses the less obvious effect of future inflation – the real loan cost. Repeat this over thousands of customers and voila: a housing bubble.

Clearly the money illusion isn’t wholly and solely responsible for the mess we’re in now. But here’s one thing you can take to the bank: The human brain isn’t a purely rational economic machine, and it’s our weird relationship to money that we need to keep an eye on as well as the market.

Here’s something that’s no illusion though: the Email or RSS updates to Very Evolved. No inflated numbers, just cool science.

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Weber, B., Rangel, A., Wibral, M., & Falk, A. (2009). The medial prefrontal cortex exhibits money illusion Proceedings of the National Academy of Sciences DOI: 10.1073/pnas.0901490106

The house always wins

Gambling is a widespread cultural phenomena that has spanned thousands of years and almost every civilization that’s appeared on the face of the planet. And as long as gambling has been around the odds have always favored the house to win. Logically it has to be this way; otherwise casinos would have gone out of business millennia ago. But with the odds stacked against us and our rational brain aware of this, why do we bother to gamble at all?

Even more perplexing is that for the majority of us, a wager here or there isn’t a problem, and the allure of gambling falls well into the realm of entertainment. But for some it’s a debilitating addiction that is not dissimilar to substance abuse.

What binds all of these together? It’s all about how our brain handles the wonderful sensation of reward.

Reward

In the current study, researchers from Cambridge examined the brains of 15 people with a fMRI machine while they gambled on a slot machine. What they found was that brain activity for winning spins was greatly increased in the ventral striatum and anterior insula; part of a neuronal circuit that is well known as the reward system.

In a nutshell the way our brain processes our feelings of reward and success at a job well done is: trigger > reward > reinforcement. In gambling the trigger is of course money, and this fires up the reward systems in your brain, which are largely governed by release of the neurotransmitter dopamine. This feels great, you are rewarded and you want to do it again and the trigger is reinforced as something that’s good.

This process isn’t limited to gambling or money of course; it’s also the same thing that happens when you eat delicious chocolate, or why I turn into a slobbering canine when I smell bacon. You might also have guessed that this is part of the mechanism behind addiction to heroin and other drugs of abuse, which we can define as uncontrolled reward and reinforcement.

Close enough is good enough

That gambling activates the reward system isn’t a surprise. But the astonishing observation from this study comes when we look at brain activity when the subjects “almost win”.
In this case “almost wining” was when the slot machine dials stopped tumbling and 2 out of the three symbols lined up on the payout line and the third matching symbol appeared just above the “win line”. When this happened, the pattern of activity was in the same brain areas as when they actually won.

It seems that a near-miss is enough to trigger the reward > reinforcement cascade, and is effectively encouraging us to continue gambling.

As if to drive the point home the brain pattern of near-miss activity was also very different from the patterns observed when the slot machine spin was still a losing spin but where none of the symbols were anywhere near close to matching – despite the economic result being the same: zero dollars won.

From an evolutionary perspective, being rewarded or encouraged by a near-miss can be very advantageous. Whether you are a Stone Age man throwing a spear or a couch potato playing guitar hero, almost hitting your target is a signal that you are improving, and should continue.

Knowing the odds

While it wasn’t previously clear how it worked, the near-miss phenomena has been known for some time. What is perhaps more insidious though is that the optimum rate of near-misses to keep people gambling has been calculated at 30% and subsequently implemented into the programming of many slot machines.***

It’s important to note that the people tested in this study weren’t problem gamblers, but regular people just like you and me. The cycle of trigger and reward is a normal one that helps us predict future successes by observing the outcome of our actions. Sadly, when games of chance are involved, we see patterns that don’t exist and fail to realize our actions do not influence the outcome.

***UPDATE: This was the subject of some lawsuits and in the comments below slotdesigner indicates that this is no longer allowed in many US sates. In other countries and online however the issue remains murky.

If you want a guaranteed successful outcome then you can subscribe to the instant Email updates or RSS feed for Very Evolved. Paying out in pure science since 2009!

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Panic on the stockroom floor and giddy excitement watching the lottery. Emotions are intimately tied up with moneymaking decisions. But why does money have such a magical influence on how our brain makes decisions? And when it comes to money, are our brains hard wired to judge how risky something is?

This is your brain on money

We make decisions all the time. You probably decided what you were going to have for breakfast this morning without much difficulty. On the surface it doesn’t seem like a big deal. But how did your brain consider all the options, and decide what the right answer was? And is this the same way that we decide what to do when cash is involved?

Appropriately enough, the classic approach to understanding how the brain makes decisions comes to us from the field of economics. Options are weighed, outcomes are predicted, and the statistical likelihood of a desirable result is calculated. It’s nice, it’s neat and choosing the most economically desirable outcome is always the right decision. It’s a great description of how you choose between cornflakes or toast.

But this doesn’t accurately describe the human brain when money is involved.

The inside of our skull is a messy chaotic place, full of irrelevant information, inaccurate memories, distractions and emotions. And it’s emotions in particular that play a huge part in judging risk and risky financial decisions in particular.

A simple, but elegant example reveals how our emotions are intimately tied into how we perceive money. And it’s in a way that is divorced from cold hard economics. When a group of people were asked to gamble a sum of money, the emotional response to the wager depended on the perceived value of the outcome AND the likelihood of the desired outcome vs. the alternative.

In plain English this means it feels better to gamble and win $0 when the alternative was only $10. Compared to feeling much worse winning $0 when there is was the possibility of $100. In the same vein; winning $50 feels better when the odds of success were only 10% rather than 90%.

The emotions felt after gambling are profoundly influenced by this “what might have been syndrome”. Oddly enough this even happens before we make that financial decision – you expect to feel worse if you think you’ll win $0 instead of $90.

So decisions about money are all tied up with thoughts about risks and rewards. But we don’t all make the same bets or have the same sickening sense of loss when money goes begging. Are our brains wired differently?

Risky business

From a superficial perspective, persistent risk-taking behavior is seen as an abnormal, almost a pathological condition. A self-destructive spiral into loss of control and loss of reason, paralleling drug-seeking behavior.
But we all take risks with our money: from simple decisions like which gas station to buy fuel at, to more complex situations like what investments to make for our retirement. Clearly, the nature of risky decision-making isn’t as black and white as being a drug addict. How do we explain why some of us take risks with our money on the stock market or by starting a new business? A recent commentary in the journal Nature may give us a clue.

Entrepreneurs vs. managers

Dispensing with the simple “gains and losses” view of calculating a decision the researchers took a closer look at real world examples of how entrepreneurs (risk takers) and managers (risk avoiders) behaved when faced with two types of decisions.

Cold processes. These are decisions and problem solving tasks that are emotionally neural and require cold hard logic to solve. In this case the test involved moving a number of colored balls to match a pattern in the least number of moves possible.
Deciding what to do here primarily involves the dorsolateral prefrontal cortex region of the brain – No consideration of reward vs. punishment here, just cold and boring choices.

Hot processes. These decisions are heavily concerned with evaluating reward and punishment, and the emotional consequences of either outcome. The test again is a gambling task. But in this case, the odds of winning were made known, so using the cold processes above, you should always be able to calculate the best possible bet to make.

Unlike the cold processes the medial and orbital regions of the prefrontal cortex are very active in these tasks and they connect with the amygdala – a region that has strong controls over our emotional state.

The results were enlightening. The entrepreneurs and managers scored similarly on the cold hard logic test, so reasoning and logic wasn’t different between the two. On the hot process test, both groups also gambled in a similar way, and both adjusted their betting strategy in a logical way when the odds were changed.

However there was one telling difference: the entrepreneurs displayed much riskier behavior by consistently betting larger amounts when gambling.
The gambling task also revealed another facet of how our brain handle risk. Normally, gambling behavior on the test correlates with age – the older you become the less financial risks you take. But the entrepreneurial group with a mean age of 51 had scores similar to teenagers and young adults (17-27) while the mangers were normal for their age.

Overall the behavior of the entrepreneurs was skewed towards greater risk seeking or higher risk-tolerance. In essence: Larger rewards are available for those who bet more, with the downside that there is also the possibility of greater losses.

So why aren’t these impulsive risk-taking behaviors destructive like a drug addicts?

By and large entrepreneurs are very creative and the results of successful risk-seeking behavior are largely positive. Increased personal wealth and increased wealth for society as a whole. Combine this particular flavor of risk-taking, risk-tolerance and cognitive flexibility and you have a winning combination.

But can you learn to become a financial risk-taker?

You can learn the basics of business for free, and there is also no shortage of “entrepreneurs” willing to teach you the “secrets” of success if you’ll just buy their ebook. But largely these boil down to the traditional fundamentals of business and entrepreneurship: risk minimization and risk aversion tactics through extensive planning and market research.

This is obviously a key part of the curriculum, but having peeked into the minds of entrepreneurs perhaps teaching risk tolerance should augment this – both at a personal level and through the lens of financial decisions. But teaching and learning might not work for everyone. Are we fundamentally limited by our individual biochemistry? Can anyone become risk-tolerant?

All of these decision-making processes I’ve discussed are intricately intertwined with the biochemistry of the brain and to big name neurotransmitters you’ve probably heard of like dopamine. Knowing the brain regions involved, and how they become active when making different choices means we have a rough sketch of the entrepreneurial brain. Using this neurochemical map it should then be possible to ask: Can we drug our way to entrepreneurship?

It is indeed possible to change the risky-decision making results of all the tests I’ve mentioned with psycostimulatnts like Ritalin. But these neurochemical tools are still crude, and the map is still only a sketch. To make any meaningful changes a more nuanced manipulation of the systems involved is required than technology will permit. But there is another way to achieve the same results right now: Exposure to other entrepreneurs.

Clusters of startups like silicon valley and research triangle aren’t accidents. Perceptions of risk can decrease when everyone around you is more risk-tolerant. Combine this with exposure to very creative people with high cognitive flexibility, and you have a culture that fosters positive risky financial behavior.

Risk in and of itself is not a negative thing. There is considerable financial risk in starting any venture and if we all avoided it there would be no innovation. The question you should ask yourself is: Does your brain think about money like a manager or an entrepreneur?

To fire up different regions of your brain you won’t be risking anything if you subscribe to the RSS or Email updates.

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On the surface of it this may seem like a trivial exercise, but it’s they key to any structured scientific approach to reaching your goals. Mountains have peaks, oceans have beaches.

These are very clear markers to aim at and symbols that definitively identify when you’ve successfully climbed or crossed them.

Without a clear definition of what you’re trying to achieve then of course it’s impossible to reach. How can you finish a task if you never know when it’s complete?

Taking this one step to define happiness is essential, and will have a greater effect on making you happier than any other article in this series.

Defining Happiness

Of course there is a nice biological mechanism that underlies your feelings of happiness, with some big name brain regions and neurotransmitters that have a huge influence on your mood. You’ve probably even heard of a few like dopamine and serotonin. Without this basic scientific understanding of happiness and the brain there would be no Prozac or other anti-depressants.

But despite how far our comprehension has advanced in the last 50 years, our knowledge of how happiness as biochemistry works is as crude as saying the wheels on a car go around and then it goes forward. There are many nuanced processes that occur at the biochemical and molecular levels that add up to dopamine and serotonin being released. As a consequence of this we experience a reinforcement of feeling satisfied or pleasure after taking doing whatever it was that caused us to feel happy.

Alas if this were the whole simple story then the whole self help industry could condense “how to be happy?” into a simple solution: Use lots of heroin. No, the nuanced flavors of happiness are more than the sum of the biochemical reactions in our brain (at least they are more complicated than pure chemistry can solve for us right now). To understand happiness we need to use the next best scientific tools at our disposal: psychology and psychiatry.

This isn’t the whole answer to understanding happiness either – psychological studies are themselves limited and crude, just in different ways than biochemistry. Happiness is a tough thing to study in a laboratory setting – let’s face it, we can’t know with certainty if a lab rat is feeling pleased or annoyed. Therefore the best tools we have for scientifically studying happiness come from simply asking people about what makes them happy.

But that doesn’t mean we are just groping around in the dark here for any self help mumbo jumbo on what happiness is. There are some very sound scientific studies that have examined what makes people happy, even if we don’t know exactly how they make people happy. And perhaps that’s good enough to start with.

Theories of Happiness – Right Now or Here for the Long Run?

The first big theory of what happiness consists of is a nice logical, almost mathematical approach. Schopenhauer was perhaps the first to articulate it as: Happiness is merely an absence of pain, or more stoically: Happiness is minimizing pain and maximizing pleasure.

This definition, known as the hedonistic view, is probably the most familiar to people. It does feel limited in its scope though as it is more heavily weighted to assigning happiness to things with immediacy, those things that are bringing you pleasure right now. That amazing meal you had at that restaurant, which filed your senses with delight and exposed you to amazing new flavors. This can certainly be described as bringing you happiness. But what about that amazing meal you ate 2 years ago, do you even remember that? Perhaps it is a mistake to think of all the happiness in our lives as columns in a ledger book that contains pain and pleasure. Do you even subconsciously total these up to a positive or a negative number at the end of the day, week, or at the end of our lives?

The second view is that happiness is satisfaction in your actions or even more generally with life as a whole. This more nuanced view of happiness can incorporate pain and boredom as elements of happiness rather than the plus and minus seen above. For example, I don’t enjoy washing the dishes, but it does make me feel quite satisfied to see them done and the kitchen orderly and ready to create another meal. Importantly though, happiness and satisfaction are not the same. No one strives to just be satisfied, we seek out ways to be happy. Perhaps then we can expand this definition into happiness is a large quantity and breadth of satisfaction in many aspects of life.

As with most competing scientific theories, perhaps the truth lies in a combination of both. It’s hard to imagine pursuing only those little things that bring you pleasure and avoiding anything that’s unpleasant and then expecting to have a nice home and a long comfortable retirement. Conversely are you really happy if you work in a soul destroying job, hating the 8 hours of every day for 10 years so you can own that comfortable home only when you retire?

While we now have some general guidelines as to how to define what happiness is, it is still something intensely personal. And that means you need to customize the definition to you before you begin to try and increase your levels of happiness.

Realistic Goals and Defined Goals

1) Identify the things in life that currently make you happy. Family, Health, Eating out, Cars, your job etc write them all down no matter how trivial.

2) Write down all the things that you want that you don’t have that you think will make you happy.

3) Be critical. What goals in step 2 would impact on the things that make you happy now? Can you afford that nice sports car – what would you be giving up?

4) Acting on you goals. Two simple choices remain now: Either change your desires/expectations to match the world around you or Change the world around you to match your expectations/desires

Next up in this series on happiness we’ll explore ways to increase your happiness and start realizing the goals in step 4. It sounds like it could be a long journey but the reality is – The hardest part is over!

Once you’ve actually defined what happiness is to you then more often than not this is enough to make it obvious what you need to do next to make your life happier.

To ensure you catch the next in the series try subscribing to the RSS or Email updates. It would certainly make me happier.

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Why do we feel strong emotional attachments to inanimate objects? Simple, you can blame your biology. But by understanding the way the brain works, can this help us get what we want?
Some of you looking at the Lotus Elise (pictured above) will see something ugly and wildly impractical. But that’s not what I see. This car makes me smile just thinking about it, it brings warm emotions to the surface and strong sense of desire bubbling up in such a primal way that I feel a connection to this thing, like it was alive.

This isn’t unique phenomenon by any means, but for you it might not be this Lotus or a car at all, it can be iPods, expensive shoes, that big glossy TV or a shiny piece of jewelry. Whatever thing it is that stirs your feelings, at some time during your life there’s been some inanimate object out there that you’ve formed a strong emotional bond to. But why on earth does our brain work like this? Forming an emotional connection to other people is understandable, but why a hunk of metal and plastic?

I’ve mentioned in several articles now that we’re still walking around with the same brain that evolved during the Stone Age, so the question becomes even more bizarre: why would a cave man fall in love with a shiny new toy like the Lotus Elise?

How it works

Dopamine. This is the key neurotransmitter that governs your motivation for reward seeking behavior. It’s the rush you get from dopamine release that fuels drug addicts and compulsive gamblers. And to a lesser extent it’s what happens to you every time you see that beautiful piece of art or slickly designed product you want. It’s a just a teaser though, a preview of what’s pleasures are on offer. It’s your brain’s way of saying to you “see how good that felt? Well if you buy this thing imagine how much more dopamine I’ll release and how awesome you’ll feel!” At this point it’s the promise of reward that’s leading to reinforcement of your positive feelings.

Reinforcement. The next phase in reward mechanism is repetition. The more often you encounter a stimulus, and the more time you spend thinking about it, the better you remember it and the more important your brain thinks it is. It the same way you learn anything. In your brain the hippocampus works to solidify your memories and experiences. With repeated feelings of desire and lust towards your dream car or iPod etc. it’s now it’s beginning to form positive memories of your target and filing it away as something that’s worth remembering well.

Now that it’s easy to remember you like this object, the feelings of lust and desire are a good shortcut method that your brain can use to keep you focused on your goal. This is a great evolutionary trick that may have really helped our ancestors survive. It’s a pretty abstract task to spend days sharpening a stick and chipping away at a piece of rock till it’s got a sharp edge – but if you’re motivated to catch a mammoth then these objects are associated with a very desirable outcome – food, clothing and survival.

So how can we use our knowledge of this encoding process to improve our chances of getting that new toy?

Get what you want by syncing reality with your brain

Clearly define what you want. You brain is good at handling abstract concepts, but it’s way better at something that’s solid, obtainable and easy to understand. Wanting a million dollars is nice, but it’s such a large abstract number it’s hard for the frontal cortex of your brain to really nail this down into something that’s easy to relate to. A concept that’s harder to relate to is harder to comprehend, harder to feel any emotion about, and harder for your brain to remember. You don’t really want a big number, you want the freedom and possessions that a million dollars will buy you. Define those instead.

Positive association = motivation. So after you’ve clearly defined what you want in the previous step, you’ll want to make your goal more real. Write it down, get a picture or some other physical object that represents your target and carry with you. Now when you’re working towards your goal and you get distracted or start to procrastinate, pull out your note. This will activate your hippocampus, retrieve memories and feelings linked with what it is you want. The more you do this the more you’ll associate the task you’re working on right now with your final target and the more likely it is that you’ll stop being distracted and just get it done already.

Don’t want it. This may sound kind of paradoxical but often the most positive outcome may be to not get what you think you want. For example that zippy Lotus Elise is gorgeous, fast, fun and really can bring a lot of joy into some people’s lives. However it’s a two seater, expensive, and requires more attention than a Toyota corolla. If you had a family of 6 kids and a bad mortgage then fulfilling this desire would probably lead to greater unhappiness.

So how to reprogram your response? Almost the reverse of what I’ve mentioned above. A little negative association here will go a long way. Start by writing down what it would cost you if you had it – not in money but emotionally. Would you be sacrificing money you could have spent on your children’s education? Would you be asking others to sacrifice on your behalf? Would you really be happy if you and others had to sacrifice things they cared about to make your wish come true? Keep this piece of paper with you and pull it out whenever you spend a lot of time thinking about the things you want to buy but shouldn’t.

Sadly none of these guides will make what you want magically appear, but  it will give you something much better and very healthy for you – focus and motivation. These are two valuable tools that when used with purpose, can really change your life.

Now you have a handle on how your biology works when you fall in love with your car, you can head down the long road owning it or any other shiny toy a reality. Time is the key here, no shortcuts, this is a training exercise and the trick is to keep your brain on track.

Right now my cortex is certain you’ll have a positive association if you click here and subscribe to my RSS or Email feeds. Give it a try, there’s a little bit of a dopamine reward if you do.

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