Getting a Grip on the Greenback

Our emotions evolved to handle concrete challenges to survival and social interaction; money is essential to survival, but our dealings with it are hardly straightforward.

Money is a relatively recent historical invention, perhaps no more than 3,000 years old, invented in Mesopotamia when precious metals were traded for livestock. Currency is therefore a novelty to which our 100,000-year-old brains are not automatically adapted. It is the convenient shorthand for complex exchanges. And problems arise when we approach financial calculations the way we approach most types of information gathering.

We learn by seeking patterns and causal connections derived from past experience (we found fruit beyond those hills), which allow us to make accurate predictions about the future (head for the hills!). Our ancestors learned what constitutes profitable investing of time and energy through trial and error, or by building an oral database, such as what routes are passable in winter. Currency, by contrast, is not only abstract, it's never absolute. Trading an apple for an orange is immediate and concrete; trading dollars for euros can be a windfall or a swindle, depending on who's got which currency at what point in time.

We probably possessed basic numeracy very early in our history. Comprehending numbers and quantity certainly confers survival advantages: Are we outnumbered by a band of potential enemies? Have I received a portion of food that adequately compensates for my contribution yesterday? The difference is that in ancestral "markets," feedback was tethered to actual occurrences.

This is worlds away from Bloomberg terminals and the mysterious ticktock of every publicly traded company. Today's market requires a deep understanding of the coldly empirical spreadsheet, and even that knowledge won't necessarily allow us to make accurate predictions. Gary Becker, a Nobel laureate in economics, admits that economists and business experts do not know why booms invariably come to an end. Often, a random "dartboard" approach outperforms the experts on picking stocks.

Terry Burnham, an economist at Acadian Asset Management in Boston, argues that our "lizard brains" are ill equipped to deal with the market's unpredictable patterns. We erroneously buy at market "tops" and sell at market "bottoms." We fall in love with a stock if others value it highly, much as we would have valued information when we lived in a band of 150 people, most of whom were kin.

Our purchase patterns reflect the learning style that helped our ancestors do well. However, such lemming-like decision-making is disastrous today, because we'll buy overvalued stocks and hold on to them far too long.

We learn and codify what works. Markets, however, are not amenable to trial and error. Markets are irrational in the sense that they are not historical—the past does not predict what the market will do tomorrow. The problem is that our evolved tendency is to learn from that very past. But finding predictable patterns in the market is like seeing Mona Lisa in a Jackson Pollock.

Another vestige of our past that gets us in trouble: We seek immediacy and unconsciously discount future value and future debt. We want it now because the value of most items in the ancestral environment had a shelf life of a few days. Meat, fruit, and water supply had immediate value and a steeply discounted future. When asked to take $200 now instead of $220 dollars in a month, most people choose $200 now. Over a lifetime, this bias keeps us from amassing wealth.

We also disregard the costs we incur in the future, especially when dealing with ultra-abstract lines of credit. We subconsciously believe that we are getting something for nothing, obtaining products without incurring costs. Credit-card companies literally bank on our future discounting. Minimizing future value or future costs made sense in an environment where we weren't as likely to live to see the consequences of long-term decisions as we are today.

Then there's our "recency" bias. We tend to act impulsively when it comes to new information or gossip. We are inordinately affected by recent news, giving it a lot of weight before it is proven, because our ancestors on the savanna had to rely on ever-shifting cues to figure out what to do next.

It's hard to stick to a long-term financial plan; a powerful recent drop in a stock, a murmur on a Web site, or seeing an illusory "trend" could send us into a panic. In such cases, you might be best off refusing the emotional "lizardly" reaction to cut and run. Sticking to a plan requires dealing with the anxiety our ancestors felt with new information. Our evolved tendency to get anxious could be lifesaving when tethered to the predictable, but crippling when it comes to markets.