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Afternoon (evening) brain snack: The Devil That You Know

This week, I’ve decided to do a little series of “afternoon brain snacks” from the seven chapters of Why Smart People Make Big Money Mistakes and How to Correct Them: The Science of Behavioral Economics by Gary Belsky and Thomas Gilovich. Sort of a summary/commentary. Today’s chapter is titled “The Devil That You Know.”

Sometimes our biggest screwups come not from changing but from choosing not to change. One of the byproducts of loss aversion is not wanting to admit it’s a loss. So people hang onto failing stocks in the hopes that they’ll rise again. Or people are too nervous about deciding between a few good options that they won’t do anything at all.

For example, when people were told that (hypothetically) they had lots of money to invest and 4 options, they didn’t cluster around any in particular. Two were more popular and two a bit less.

But when they were told that the money was already invested in one of the options and they could change to the other 3, more decided to stay with the status quo.

Fear of loss can also lead to us putting too much value on things you own because they’re yours. You might charge $200 for a ticket that cost you $100 and is now selling for about $150. But you wouldn’t be willing to pay that. Your price is based on the fact that you’re putting an irrational value on it and you don’t want to lose money on the sale.

This can be particularly bad if you’re selling your house. If the valuation isn’t based on things like the market but instead is on how much you think it’s worth, then it won’t sell.

So here’s some tips they give us.

  • Remember: deciding not to decide is a decision. So there.
  • Don’t forget opportunity costs. No financial decision is perfect. And if you neglect something important because you can’t make it perfect, you’ll lose. Probably. Like not buying stocks until you’re 40 vs. learning a bit and buying some simple funds when you’re 25. Even if the funds aren’t stellar, they’ll do better than nothing.
  • Put yourself on autopilot. Come up with a good strategy and just go with it. Maybe do some dollar-cost averaging. Set your savings to be automatic. Make it easy for yourself once you’ve made a good choice. (This doesn’t mean not reevaluating it from time to time, but not every day or week!)
  • Play your own devil’s advocate. If you’re tempted to go with the status quo, ask which you think would be the best choice if the status quo and the new possibility were equally new.

I hope I did a decent job of presenting this chapter. Basically, learn to make decisions. Then learn to make it easy for yourself to stick with them as long as they’re learning. And don’t beat yourself up for not being perfect. I’ll bet you that even Warren Buffet isn’t perfect!

{ 4 comments… read them below or add one }

Andrew Stevens October 24, 2007 at 7:43 pm

Isn’t that a Rush lyric from “Free Will”? “If you choose not to decide, you still have made a choice.”

GreenPanda October 25, 2007 at 10:35 am

I agree that oppurutnity costs pay a factor in making a decision. As for investments the opputunity costs of not starting early are huge. Start now and minimize the loss and maximize your gain.

Fabulously Broke October 27, 2007 at 7:52 am

I *heart* your afternoon brain snacks 🙂

Esp. the bit about putting SOMETHING away when you’re 20 instead of 40 because of the opportunity cost…

MsMiniducky October 30, 2007 at 10:45 pm

I particularly like this one as it combines with my mail to kick my butt in gear on the little things that just keep slipping by.

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