Next week, I will be speaking at the CCH Connections conference in Orlando, Florida, and I get to talk about one of my favorite topics–behavioral finance. Behavioral finance looks at the ways in which people are not rational about their money. Inherently, we all know that other people aren’t rational about their money. When we’re feeling honest, we can acknowledge that same characteristic in ourselves. For example, most of us get more upset when we lose money in the stock market than when we become happy when we make money. We tend to look at recent events and assume they will happen again, even if they are relatively rare. I still have clients tell me that they won’t invest in technology because of what happened in 2000. Badly burned, we tend to crawl into our shells and peek out fearfully once in a while. What’s an investor to do, when most of us are responsible for taking 401(k) contributions from our employers and our own deferrals and turn it into enough money to last for 30 years in retirement?
Daniel Kahneman, Nobel Prize winner in economics, offers some great perspectives in his book, Thinking, Fast and Slow. Basically, the premise is that our logical brains defer to our irrational behaviors very quickly, logic is tiring, and we tend to take the path of least resistance. For much of our lives, this works well; however, when we need to think clearly, we need to try to help our logical brains and recognize specific types of errors in thinking that are common. Kahneman refers to these two opposing forces as System 1 and System 2; System 1 is automatic, while System 2 is orderly. By recognizing we all have these tendencies, Kahneman is hopeful that we can train ourselves to act in ways that are more logical.
Kahneman’s work has huge ramifications as we analyze advertisements, listen to promises of low-risk questionable investments, and try to determine our own risk tolerance levels. Basically, the entire advertising industry is determined to keep System 1 firmly in place. Well meaning friends and acquaintances who are already firmly planted in System 1 will call us crazy as we try to utilize System 2. However, the effort is worth it.
This is my favorite book, and it has been for about a year and a half. Kahneman’s writing is approachable and fun, using great examples that will expose how you might not be as logical as you think you are! Buried in the entertainment are powerful principles. Check it out….it’s worth your time!
Be Prosperous! Peggy