What emotions do you experience when you think about money? Fear, greed, hope, anxiety? The good news is that if you do, you are perfectly normal. The bad news is that these emotions play havoc with our finances. In fact, scientists say that when it comes to financial decisions, how we feel about money drives 80% of our thought process whereas our rationale drives just 20%. Is it any wonder we make costly mistakes?
According to Nobel Prize winning economist Daniel Kahneman, we are prone to impulsive, emotional, irrational ”fast thinking”, often in situations when we really need the help of the rational “slow thinking” part of our brain.
Here are some common errors our badly-wired brains can make …
1. Overconfidence. We think we know more than we do and we think we’re better than average at almost everything, from driving to parenting. In investing this takes the form of taking too much risk and overtrading shares – traits that are also, perhaps unsurprisingly, more pronounced in men.
2. Confirmation Bias. We tend to only use information that matches our existing beliefs and ignore data that suggest otherwise. For example, when we buy a house we seek out only opinions that say “of course house prices will never fall”.
3. Anchoring Bias. We rely too heavily on the first piece of information offered when making decisions. Advertisers use this flaw to nudge us, very successfully, into economically irrational choices – 10% off a €200 pair of shoes can suddenly seem like great value!
4. Loss Aversion. We prefer avoiding losses to making gains and we place a higher value than others on things we own. This explains for example why so many investors held on to Irish bank shares all through their catastrophic decline.
But there are ways to to make better financial decisions …
1. Be Aware. Try to recognise situations where you may not be thinking rationally.
2. Slow down. Disengage your fast thinking brain by delaying decisions.
3. Research. Remember to spend plenty of time objectively considering major economic decisions such as buying a house, getting a mortgage or starting a pension / investment.
4. Have a Plan. Make money decisions based on a financial plan. This ensures a rational consistent process.
5. Outsource. Failing all of the above, seek the objective opinion of an unbiased independent advisor.
As a totally unbiased financial advisor I see two parts to my job; firstly helping clients avoid making these all too human mistakes, and secondly, helping them navigate the horribly complex world of financial and investment products (which deliberately take advantage of our emotional weaknesses).