Most financial decisions come down to a battle between the heart and the head. The interesting thing is many people totally discount the impact of emotions and contend that their decisions are based only on reason and logic. Substantial peer-reviewed research in psychology and neuroscience finds this assertion to be almost entirely false. In fact, the opposite is true.
Why do we pretend cognitive biases and emotions barely register on the decision-making dial? We think we are making rational, smart investment decisions. But are we ?
Here’s the truth. Research has shown that our own behavior is more important than all the other factors combined when it comes to decision making. That’s right. Forget about all the investment folklore of trying to find the best investment manager or the perfect time to invest. All those aspects pale in importance to cognitive biases that foul-up investment decisions. I have described four top cognitive biases here:
Our human behavior is generally thought to be the result of two primary inputs, the individual and the overall environment. Each of us inherit some of our money personality from our parents. How money was discussed (or not discussed) within the household and the role of money in the family setting have an impact. Early experiences with money also help form the money personality that we carry into adulthood.
From there, in terms of financial decisions, the underlying environment in America is one where we are programmed, (by the financial product marketers and financial media), to believe that there are methods available to “outsmart” the financial markets. While this may be true it is only true by luck, not by design. No one has a model or method to consistently beat the market, despite our desire that this were so.
The “Outsmart Fallacy”
In my experience, successful business owners and professionals are easy prey for the “outsmart fallacy” product marketers. Generally, these individuals have worked hard, studied hard, and made mostly good choices that have led to some level of success. They believe the same process likely applies to making investment decisions as well. This leads directly to Information Bias that I described above.
Smart people think they can eliminate behavioral biases but there is scant evidence that this actually happens in real life. I saw an interview recently with Nobel laureate and author Daniel Kahneman (Thinking Fast and Slow), where he talked about his own personal struggle with behavioral biases. He indicated that despite his lifetime of research into behavior, he still can’t overcome the strong “factory wired” tendency to make decisions emotionally. If someone as well versed on the heart versus the head matter as Kahneman fights this, why in the world do think we can do better?
Are you Hurting Your Future?
All of the clients we work with have experienced emotional pain at some point from financial decisions not working out as planned. The issue which few investors realize, however, is no one has the power over specific financial outcomes. What we do have control over is how we behave. Nothing else.
The best antidote to cognitive biases is to allow your behavior to be governed by what you want your future to look like. Is your behavior helping or hurting your future? What amount of money is enough? What’s the right amount of risk? Start there. Ready for a real conversation?