With some 95% of its activity occurring subconsciously, your brain can be quite tricky. With every spontaneous signal, our cerebral synapses expose us to countless behavioral biases, duping us into making misguided money moves long before our rational resolve kicks in.
“As investors, we leap before we look. We stay when we should go. We cringe at the very risks that are expected to generate our greatest rewards. All the while, we rush into nearly every move, only to fret and regret them long after the deed is done.”
Since many of our most powerful biases are based on reflexive rather than reflective thinking, it’s not enough just to be aware of them. We must also learn how to defend against them. Or better yet, turn them to our advantage. How do you do that? By tricking your brain right back.
Biasing Toward Better Behaviors
To illustrate, here’s one “trick” that has worked incredibly well for retirement plan participants.
When companies started offering 401(k) retirement saving plans in the 1980s, employees were traditionally invited to participate, but were not automatically enrolled. In other words, you had to take deliberate action to get started, as well as to increase your contributions over time.
Today, you still get to decide if, and how much you’ll contribute to your company retirement plan. But instead of requiring you to opt into participating, many companies now auto-enroll you unless you deliberately opt out. Your employer also may automatically increase your contribution rate to the maximum allowable amount over time, unless you say no. By requiring action to avoid saving for retirement, you can trick yourself into saving more than if you had to take action to start saving. Thus, we recruit our tendency to favor inertia, using it to improve on, rather than detract from retirement plan participation.
Auto-Save Yourself
In their aptly entitled book, “Nudge,” Nobel laureate Richard Thaler and co-author Cass Sunstein refer to this sort of trickery as a “nudge.” As they describe it, nudges should not replace your free will; they should just make it easier for you to make your own best choices.
Nudges don’t have to come from outside influencers, either. You can nudge yourself.
For example, we’ve long known about putting your personal saving habits on auto-pilot. In 1926, when George Clason first published his timeless classic “The Richest Man in Babylon,” he described this as learning to “pay yourself first.” By forming lifelong “pay yourself first” habits, you can replicate within your personal accounts the same saving success found in the retirement plan world. Leveraging what Thaler and Sunstein refer to as our “yeah, whatever” bias, the trick is to shift away from saving what’s left after spending. Instead, set aside your savings before spending the rest. In so doing, you’re once again using inertia to your advantage.
Don’t Look Now
We’ve also long known how susceptible investors are to FOMO (fear of missing out), loss aversion, recency, and a bevy of other behavioral biases that trick us into chasing breaking news, rather than maintaining a more sustainable long-term perspective.
Reactionary trading can cost you. For example, an article in Canada’s The Globe and Mail, “Check in, freak out,” reported:
“A study conducted by U.S. robo-adviser SigFig found that its investors who checked in on their portfolios every day earned 0.2 per cent less each year in return than the average. Twice-a-day logins doubled the performance gap.”
Watching the market’s bouncing ball can also leave you more unhappy than if you only check in periodically. As Nobel Laureate Daniel Kahneman observed:
“If owning stocks is a long-term project for you, following their changes constantly is a very, very bad idea. It’s the worst possible thing you can do, because people are so sensitive to short-term losses. If you count your money every day, you’ll be miserable.”
So, don’t do that. Don’t let yourself look at the market’s daily news. Instead, nudge yourself into staying focused on what really matters by limiting your looks to quarterly, or even annual performance reviews.
Mental Accounting Tricks
Mental accounting is another behavioral bias that can help or hurt you. We’ve all engaged in it when we create arbitrary rules to “organize, evaluate, and keep track of financial activities” (as described by Thaler’s paper, “Mental accounting matters”).
The trick here is to be deliberate about which money management rules you establish for yourself, and why.
For example, imagine you’ve inherited some stock your mother held most of her life. You might subconsciously categorize these shares as legacy money, and treat them differently than your other investable assets. Even if you’d be better off selling some shares to best preserve their lasting value, your mental accounting of what feels like “Mom’s Money” may stand in the way.
Instead of letting mental accounting hinder your best use of the inheritance, redirect it to make the most of her loving legacy. For example, you could consider selling the stock, accounting for most of the proceeds as “future wealth,” and reinvesting it accordingly in a less-concentrated manner (paying yourself first). You could then assign a portion of it to funding your kids’ college, and another batch of it for a fun family outing your folks would have loved.
While you’re not actually required to spend the money as accounted for, by effectively categorizing this money for these functions, you’re better positioned to enjoy the inheritance, without squandering it.
Blind Ambition
We’ve barely scratched the surface of strategies for turning your instincts and biases into wealth-building tools rather than weapons of financial destruction.
Arguably, one of our greatest behavioral foibles may be blind-spot bias, or our inability to see our own biases, even when we can readily spot the same tendencies in others.
Earlier, we referenced Nobel Laureate Daniel Kahneman who, throughout his long life, explored his own and others’ behavioral biases. Among his greatest habits was to go out of his way to seek feedback from others, especially those whose temperament and perspective differed from his own. In his final publication, “Thinking, Fast and Slow,” Kahneman explains:
“We are often confident even when we are wrong, and an objective observer is more likely to detect our errors than we are.”
At Multnomah Group, we believe one of our most important roles is to serve as our clients’ “objective observer,” holding up a mirror whenever a blind spot may be blocking their financial view. If we can assist you in similar fashion, we hope you’ll be in touch with us today.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.