Understanding Context and Perception

Have you ever experienced the following illusion? You're driving along a road with tall trees on either side. Up ahead, framed by the gap in the trees, you see a mountain. It looks huge and close, but when you emerge from the forest and see that the same mountain in the context of the sky and surrounding landscape, it looks much smaller and further away.

The mountain didn't move or shrink. Your perception of its relative size and distance changed because your view of it was no longer framed by the trees. In the same way, researchers have shown that our perception of financial data is heavily influenced by the context that frames it—even though that data is unambiguous numbers.

Camelia Kuhnen, a professor of finance at the University of North Carolina, writes that how we understand financial data is largely determined by the context we place it in as well as our past experiences.¹ This, in turn, often determines how we make financial decisions.

In an effort to better understand why people behave the way they do when it comes to money, a new field of study has emerged called neuroeconomics. Researchers in this area have focused on the biological aspects of how the brain perceives financial information. 

One surprising finding is that good news and bad news are processed in different areas of the brain. Positive financial surprises activate the brain's reward circuitry, reinforcing confidence. Negative surprises trigger the brain's anxiety circuit, making losses seem more dire and triggering defensive behavior.

In an environment dominated by losses, such as a recession, we tend to expect bad news and, so often, overweigh the negative information when it comes. This can produce beliefs that are more pessimistic than the data warrants.

On the other hand, when we learn that a decision we've made has paid off, our brain reinforces our confidence in our financial judgement through reward signals. As a result, we become primed to receive more good news and so pay less attention to new information that's negative.

These biases don't mean that we can never make good financial decisions. If we're aware of them, it's easier to ignore potentially harmful emotions and truly act in our own self-interest. "Financial behavior is human behavior," writes Kuhnen. In other words, when we can set aside the notion that our gut instincts are always rational, the better chance we have for long-term success.

We understand that strong feelings are natural when dealing with money. We've helped many clients achieve their retirement goals through discipline, planning, and dreaming big. We're here to guide and support you along your unique path to success.

 

1. http://go.pardot.com/e/91522/is-monthly-newsletter-intm-pdf/973573i/2994929051/h/ou2xakzdJ2ToUGgncvi2eh5Xb3211KRUt5xhaZEW03Q