Human brain not built for smart financial decisions
November 1, 2018
Why is much of financial behaviour so ridiculous?
Excuse me if this sounds a little insulting but many people realize they have a very poor track record when it comes to managing their finances.
As it turns out, the answer to my question is a short one.
Because we are human.
Many people think we have special skills at making financial decisions, but the cold truth is we do not.
Conventional wisdom said that humans made decisions rationally. Facts were considered, outcomes anticipated, and then the correct decision would naturally follow.
Then along came Professor Daniel Kahneman. A psychologist from Princeton University, he is known for his work in the psychology of judgement and decision-making. His work helped advance the field referred to as behavioral economics.
Professor Kahneman’s research was deemed so significant that in 2002 he became the first non-economist to win the Nobel Prize in Economic Science.
Kahneman uncovered the truth about humans — we are instinctive, not rational. Based on his findings, if we want to make better decisions we need to be aware of this fact. We need to recognize our decisions are usually based on emotions and learn to overcome our limitations.
One way around this could be through education.
A guiding principle of financial planning is to plan for the long-term. In fact, most people react to short-term news and sentiments of the day, which derails their long-term strategy.
Understanding how the human brain works can be of significant advantage to everyone on how to make better financial decisions.
Think what you want to accomplish. It could be paying down debt, saving for your children’s education, planning for retirement, or perhaps a combination of these objectives.
Have the discipline to logically think of what is important and then write down your objectives. What steps do you need to take to achieve your financial planning goals? And again, put that in writing.
Respect your own ability to problem solve your financial planning objectives. At the same time, be cautious and understand success is at risk due to your normal human emotional characteristics.