Our monkey brain. Super helpful when we need to run from a saber tooth tiger. Not so helpful when we need to make rational decisions.
This morning I cracked open a book on behavioral finance - Finance for Normal People: How Investors and Markets Behave..
Behavioral finance is a relatively new field. It acknowledges that we are not rational beings driven by logic and critical thinking. Rather we are we are irrational beings driven by emotions and shortcut thinking.
The point of behavioral finance is to understand how your mind works, so you can prevent your monkey brain from making your financial decisions for you. Like G.I. Joe said "…and knowing is half the battle."
Let's play a game. Answer the following instinctively. Without thinking.
“If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets?”
Was your answer 100 minutes? Me too.
Now think about it and answer again. Ahhhh. See it? The answer is actually 5 minutes.
How about another one? Quick! Don't think!
"Consider a deck of twenty well-shuffled down-facing cards. You know that ten are black and ten are red. You win if you draw a red card. Now consider a second deck of twenty well-shuffled down-facing cards. You know that all twenty are either black or red. You win if you draw a red card. Which deck do you prefer to draw a card from?"
Did you choose the first deck? So did I!!!
But reread it. Ah-ha!. You've actually got a 50% chance with either deck. Your monkey brain at work. (That one's called "ambiguity bias")
The reason your monkey brain can sabotage you is we make decisions with behavioral biases - assumptions our brains make to quickly fill in the missing gaps.
Again - super helpful if a saber tooth tiger is coming at you. Let's not utilize the scientific method to determine if it wants to eat us.
But not so helpful when you hold on to an investment that's tanked because you lost all that money. It only matters where it goes from here. What you already lost already isn't part of the decision. (That one's called "anchoring bias".)
People make financial decisions with their monkey brain every day. Let's find out how that damn monkey works, so we can get it off our back and back to the ice age with its feline friend.
More to come….