Your brain is making you poorer
Tea and sympathy
In this series of posts we are exploring some concepts from behavioural finance. If you want to be a better investor, we think you should start by learning more about the way you think — and how your brain can trick you into making bad decisions.
Hi! I’m Laura, and I’m a UX Engineer at Clover. I spend my days researching, testing, designing, coding and building the part of Clover that you use — the shiny, pretty face of it. As a designer, I think about biases a lot. Working in the finance world now, it’s interesting to consider how they overlap with behavioural economics (which is a fancy term for the way we behave with our money). As humans, we’re so controlled by our emotions, even when we’re trying to be rational about important things like money.
I had a catch up this weekend past with a family friend, a lady my mum’s generation who I’ve known for years. I’m going to call her Sue (she didn’t want to use her actual name). During our tea and debrief session, we got onto the topic of money.
Sue told me that she had received an inheritance. She didn’t have any short term plans for the money, but she wasn’t happy with such a large amount just sitting in a savings account. In her words:
“The interest rates the banks are offering are just… [incoherent ranting]”
She wasn’t sure what to do with that money, so she approached her long-time stockbroker and financial advisor for help. Long story short, she ended up giving it to him to invest on her behalf. Fair enough, but I was surprised that Sue couldn’t tell me what she would be spending to have this money invested and managed on her behalf. She had no idea, and she had already signed the contracts!
Sue is fairly thrifty. I’ve known her to do some serious bulk buying when non-perishable household goods are on special because she knows it will save her over time. It seems strange that someone who cares about dollars and cents at the supermarket doesn’t care about them for her investments.
There’s no going back now
When I asked her why she was using this advisor to manage this chunk of money, she said,
“It’s easier, our other investments are with him, and we’ve been using him for over 20 years.”
It’s a case of sunk cost fallacy, where we have a tendency to overvalue something because we’ve already invested time into it.
Sue had been with her advisor for a long time, so she felt like it was a good decision. In fact, she probably didn’t even consider exploring alternatives because of the investment of time and money she’d already made in the relationship.
I can see your halo, halo halo
Sue also told me that she continues to invest with her advisor because she has a good connection with him, that he makes her feel looked after and supported. In fact, her family had a history of engaging this advisor’s family as stock brokers, starting with Sue’s grandfather. She feels good about this legacy and carrying on the family tradition — it gives her a sense of continuity and well being. We know that this is a huge part of why people see financial advisors — the “bedside manner” of a good advisor makes you feel like you’re in capable hands.
It’s likely that these feelings made Sue think her investment was the right one for her, too. It’s something called the halo effect, where your overall feeling about something can cloud your judgment on the specifics. It’s the same reason why we find it hard to see blindingly obvious facts when we already have strong feelings about that thing. You may recognise the halo effect in recent news when natural health writer Belle Gibson leveraged the public’s love of #cleanfood on her blog and cookbook, but was later disgraced for fraudulent claims of having cured cancer through her diet.
One of the reasons why we feel like online financial advice is such an important innovation is that it allows you to make your decisions uninfluenced by nice suits, family history, or conspicuous wealth indicators.
It looks complicated, so you must be smart
Despite all this, Sue was confident that the investment strategy was really good. She liked that it was complex, and in order to execute the strategy she had to sign a partial financial power of attorney so he could do stuff on her behalf.
Although she found this extra legal paperwork annoying, I also got the sense that she was happy someone else was taking the reins. The investment strategy was too fiddly for Sue to do for herself, and that was actually an added bonus in her eyes. It’s a perfect example of complexity bias. Investors tend to think complex things are better because they seem more impressive. But as Burton Malkiel, author of Random Walk Down Wall Street says, “The overarching rule for achieving financial security: keep it simple”.
Recognise your biases and adjust your behaviour
Being a better investor is about recognising your limitations and then trying to work with or around them. At the end of our chat Sue did admit to me that she knew she may not be getting the best result for her money, but that feeling safe and looked after was more influential on her decision making.
Investing is scary, money is emotional and big decisions make us sweat. It’s not the best environment for cool-headed, objective rational thinking. Like Sue, your financial decision making may be largely driven by your biases, and in many ways that’s unavoidable. You can start by getting familiar with your biases, and learning how to avoid them.
- Just because you’ve been doing something for a long time or because you’ve put a lot of effort into it doesn’t mean it’s still the best thing to be doing. Now might be the right time to evaluate how you’re managing your money.
- Don’t let personal relationships, special offers or other “feel good” mechanisms cloud your judgement — even those who you feel fondly towards might not necessarily have the best solutions for you.
- Don’t be fooled by complex — or expensive — looking solutions. Just because something is complex doesn’t mean it’s effective, so it pays to research alternatives. Sometimes the simple solution is the best one.
We’ve designed Clover to mitigate many behavioural biases and help you invest with proven techniques that keep your costs low. Because in the end, we’re all just humans — and sometimes our brains can work against us.