Anika Patel Academy 197

December 9, 2013 Final Paper

Neural Activity while Choosing a Financial Advisor

For centuries, people have occupied themselves with finding new ways to

increase their income. From establishing metals as trading valuables to predicting the

fickle trends of the stock market, humans managed to create a society that revolves

around money. In response, to gain financial advantage, researchers have tried to muster

the perfect neurococktail of cognition and decision-making. Neurofinance is an

emerging field in which scientists attempt to draw the lines between our neural networks

and our financial decision-making processes. In attempt to further neurofinance research,

Russell James III, a financial advisor, decided to study how and why people choose their

financial advisors. Neuroeconomists believe that finding a relationship between our

neural processes and decision-making can help us better understand investment behavior.
Are our investment decisions a reflection our emotions? Scientists still struggle to

unearth a concrete answer to this. Neuroeconomists believe that identifying the

physiological traits that affect our trading behavior can help them further their

understanding of how our economic decision-making process works. Researchers have

tried to understand how our minds are linked to the brain by using functional magnetic

resonance imaging (fMRI). When an area of the brain is activated, the hemoglobin in the

red cells gives up its oxygen and converts oxyhemoglobin to deoxyhemoglobin. The

fMRI scan detects the paramagnetic properties of the deoxyhemoblobin. While it may

seem avant garde to scan the brains of traders in action, understanding the neurofeedback

before and after each trade made, can allow researchers to relate certain activations in our

brain to our economic decision-making.

 To help isolate areas of neural activation while making a decision, James aimed to

determine the parts of the brain activated when subjects choose their financial advisors.

This information would be of value to financial advisors aiming to retain clients and

clients choosing financial advisors. After recognizing the growing trend of investors

paying experienced financial advisors to manage their portfolios, James decided to

research why people choose certain advisors. Advisors who aim to gain large sums of

money from investors in the form of fees can benefit from such research. James decided

to focus on financial advisor selection, stock market games, chasing gambling losses, and

error detection. Financial advisor selection concentrates on how clients choose to keep

or change their advisors. Stock market games focus on the decision process of staying

or leaving the market based on its performance. Similar to a gambler continuing to

gamble despite losing, chasing losses looks into why investors stay in an

underperforming market without changing advisors. Error detection depicts a persons

ability to identify the errors of others, an important trait in determining whether to keep

or change an advisor. If an investor receives what they believe to be unsatisfactory

returns, the investor could identify this result as the fault of the advisor.
James used fMRI to find areas in the brain that become activated when changing

financial advisors. He gathered nineteen subjects, giving each a set of control buttons,

and having them look upon a screen in an fMRI machine, simulating stock market

scenarios such as a rising or falling market. Rather than buying and selling stocks

directly, this stock market simulation had each subject select one of four, different,

financial planning firms. Each firm had a different investment approach based on market

trends, growth, income and value. The subjects could switch firms at any time. During

this advisor selection period, pictures of financial planners were presented: elderly and
young people either formally or informally dressed. Next to the names of some of the

advisors read Certified Financial Planner (CFP).

James determined that during switching periods, the anterior cingulate cortex

(ACC), inferior parietal lobule (IPL), and middle frontal gyrus (MFG) were

activated. The ACC (1) is located in the inner aspect of the (1)

frontal lobe adjacent to the corpus callosum, a bridge that

connects the two halves of the brain. The IPL (2) is located on

the bottom of the parietal lobe, and the MFG (3) is located in the middle of the
(2)
frontal lobe. The ACC helps us execute our rational cognitive

functions and gets activated during error detection. The IPL and

MFG get activated during the comparison of numbers, or doing

other types of mathematics. James noticed activation of ACC,

IPL, and MFG increased during an underperforming market as

(3)
more people switched their advisors. He postulated that

subjects looked at underperformance in the stock market as an

error on part of their financial advisor and that the analysis of

portfolio performance relative to the market involved mathematical

processing. James also looked at investor behavior during quiet periods when subjects

did not change advisors. During non-switching periods James noticed most subjects

chose advisors distinguished as CFPs, rather than based on their appearance, however,

when the subjects experienced underperformance, the CFP label became less

significant. By recognizing such trends in the data he collected, and by locating the parts

of the brain activated while a subject chooses her advisor, James helped further our

understanding of the neural processes involved in economic decision-making.

 James research provides advisors with an understanding of client advisor

selection and retention process. Advisors could potentially maximize their profits by

exploiting this knowledge. As James experiment determined, IPL/MFG represent neural

areas that control our mathematical comparison functions. If presented with data with

which clients can compare their performance with the overall stock market, then their

IPL/MFG will most likely activate. An activation in the IPL/MFG not only shows a that

client is comparing data presented to them, but also that they are deciding whether they

would be more successful with a different financial advisor. Through the eyes of a

financial advisor, activation of the IPL/ MFG poses a potential threat to their business.

One possible way to avoid this outcome would be not to include benchmark comparison

data when discussing financial performance. What if advisors were to use heuristic

arguments, such as explaining to clients that a poor return in falling markets represents an

opportunity to buy more shares cheaply? This would draw the clients mind away from

blaming the financial advisor for a poor return. The error detection center in the ACC

would not get activated, and thus the advisor would not be terminated.
Financial advisors can ensure and even increase their number of clients by simply

exploiting the concept of chasing gambling losses. When normal people are faced with a

gambling loss, the error detection center in the ACC activates, stopping the gambling.

Habitual gamblers view losses as something they could have almost won, causing them

to gamble until they win. Their error detection center is not as sensitive. Advisors could

try to instill this persevering attitude in their clients in such a way that any losses the

advisor makes will not lose him clients. Advisors could steer clients away from the

error detection mindset by rewiring their thoughts towards that of a gambler. Financial

advisors can achieve this rewiring of their clients minds by reassuring them that a
fallen stock market is only temporary, and it will go up. This behavior is already seen

throughout society, in sellers, especially real-estate agents. When buying a house, a real-

estate agent never begins his description of the house by listing its flaws. In fact, all that

information comes last, if at all, and may only ever be mentioned if the buyers ask about

it. Ultimately, this behavior suppresses the error detection center of the buyers. This

same concept can be applied to financial advisors, in that they can blindside their clients

to the reality of their situation, not necessarily benefitting the clients, but helping the

advisors themselves maintain their clients for a longer period of time. Although the

results of this experiment can lead to very unethical actions from the advisors in that they

now could figure out ways to exploit the behavior of their clients by not activating their

clients ACC, MFG, and IPL, we now have a better understanding of how our neural

processes relate to our choosing a financial advisor.

Bibliography
"Anterior Cingulate Cortex." Google Images. N.p., n.d. Web. 09 Dec. 2013.
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cingulate_cortex.png>.
"Inferior Parietal Lobule." Google Images. N.p., n.d. Web. 09 Dec. 2013.
<http://www.google.com/imgres?

imgurl=http://upload.wikimedia.org/wikipedia/commons/e/e3/Gray726_inferior_p

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James III, Russell N. "Choosing and Changing Financial Advisors: An MRI Study of
 Associated Brain Activations." Journal of Financial Counseling and Planning

23.2 (2012): n. pag. Association for Financial Counseling and Planning

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"Middle Frontal Gyrus." Google Images. N.p., n.d. Web. 09 Dec. 2013.
<http://www.google.com/imgres?

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ontal_gyrus.png>.