Dumb Ways to Decide?…Money Decisions
When it comes to making decisions, you’d think that financial decisions would be easiest because they are so quantifiable. Not so. Here are 5 areas where you need to watch out for your own decision making biases.
1. Don’t trust your fund manager or stockbroker.
According to Nobel prize winning behavioural economist Daniel Kahneman “50 years of research [conclusively shows] for a large majority of fund managers, the selection of stocks is more like rolling dice….”. And if you think you can beat them at their own game, Odean’s research showed that individual investors perform 3% worse the chimpanzees when trading stocks.
2. Be careful who you buy
A KPMG study of 700 mergers and acquisitions found that 83% failed to boost shareholder value. The whole set up of M&A is hugely biased, for example typically the bank that is employed to run the numbers only gets paid if the acquisition goes ahead. Also, companies analysing takeover targets often fail to consider what other options are available, what else could they do with the money.
3. Be careful how you pay
Two MIT professors ran a study where they asked people to bid for items in an auction. They found that when paying by credit card was the only option, people bid twice as much as when cash was the only option. I suspect that the future of money, frictionless payments, will mean we all spend much more than if we had to part with cold hard cash.
4. You get what you pay for
If you’re into wine, you may be aware of experiments which show that if you tell people one bottle of wine is worth $10 and another is worth $40, they will report enjoying the $40 of wine much more, even if the wine was actually the same. But did you know that they actually are enjoying it more as the brain lights up its pleasure centres more when it knows that something is expensive. And, for the next morning…do you know that the reported effects of aspirin in relieving hangovers are almost twice as high when the drug costs $2.50 vs 50c. For the same drug.
5. No such thing as a free lunch
Consider this famous experiment, Regan’s experiment on returning a favour, showing the reciprocal obligations of favours. If you’re anything like me, you probably consider yourself impervious to advertising messages and free lunches. But you and I are probably both wrong.
The effect of the free lunch is often “reciprocal access” – I am much more likely to review a proposal, have a meeting or return a call of someone I’ve had lunch with. And then when it comes to negotiating and buying a service or product, the effects of the free lunch may still be lingering. For example, should you have two roughly equivalent proposals in front of you, and one of them is from someone you know better through a lunch, which one are you going to go for?
So, let’s wrap up with my top tips for making decisions about money.
- Before employing an expert, look at academic research to see whether this type of expert is able to beat the odds. And if you’re assuming this doesn’t apply to your expert, think again. If they had a good year last year, they probably just got lucky.
- If planning an acquisition, set up two internal teams, one for and one against, you’ll get much more rigorous debate.
- Be aware of the magic spell credit cards put you under.
- It’s ok to enjoy expensive things just because they’re expensive.
- Go into a free lunch with your eyes open.
Posted by Rob Pyne