Why do smart people make stupid financial decisions? -Diana Clement

Everyone makes stupid financial decisions at some point. It could even be a lack of action that is a foolish financial decision.

These not-so-wise decisions are something I’ve been thinking about ever since a very academically talented person told me during the last downturn that he wouldn’t invest in funds because “the ones I’ve looked at have been reporting negative returns since last year.” .”

What is wrong with this statement is that investors will make more money if they buy when funds are low. How could this smart person not understand that buying cheap is an advantage? Behind this very common notion is a cocktail of psychological biases, many of which I’ve written about before. But the combination is interesting.

Some of the key factors that play a role here are:

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Loss Aversion: People tend to feel the pain of losses more intensely than the pleasure of gains. So, although the decline in markets means that it is a good time to buy due to low prices, people are afraid of further losses and avoid investing.
Recency Bias: people often give more weight to recent events and assume that current trends will continue. If markets are falling, they may irrationally believe they will continue to fall, even though history shows that markets generally improve over time.
Emotional decision making: Investment decisions should be based on logic, data, and long-term strategies, but emotions and feelings can cloud your judgment. Fear, uncertainty and anxiety about market fluctuations can cause people to avoid investments, even if it is objectively a good opportunity.
Short term focus: Worrying about returns on investments for very short periods of time causes some people to sell when they should be holding. If they saw negative returns last year, they may think it was a bad investment, even if the long-term outlook is positive. This short-sightedness may prevent them from taking advantage of a market decline.
Confirmation Bias: People tend to seek out information that confirms their existing beliefs. If someone is already fearful or skeptical, they may focus on negative returns reports to reinforce their hesitation, rather than looking at broader historical data showing the benefits of long-term investing.
Overestimation of risk: When markets decline, people often overestimate investment risk and focus too much on the possibility of further declines rather than recognizing that downturns are a normal part of the market cycle. Like my friend, they can overlook the fact that crises often present good buying opportunities.
Herd Mentality: people often follow the crowd. If others exit the market, they may feel pressure to do the same.

The human brain is not developed enough to manage money, which is one of the reasons why people make these mistakes over and over again. Financial management is extremely complex for us.

Financial advisor Tim Fairbrother of RIVAL Wealth sees smart people making the above buying high and selling low mistake, among other stupid mistakes with their money.

The biggest of these is lifestyle creep, says Fairbrother. It’s at this point that people’s expenses increase to match their income, meaning they can’t get ahead no matter how much they earn.

“Taking out high-interest loans for rapidly depreciating assets. Things like cars, furniture or boats. If you want to spend money on toys instead of borrowing money, you should always save.” Fairbrother says interest in these toys is 15% or more.

Not having adequate personal insurance is also a trap for smart people. “People often believe they are rich because they have an expensive home and a high income, but this is often backed by a very high level of debt. Only 50 per cent of Kiwis have life insurance and far fewer have income protection insurance, which insures the machine that makes the money. “They insure their homes, but they do not insure themselves.”

Not being able to make active decisions regarding KiwiSaver and other investments. Fairbrother said earning 1% less a year than they could have multiplied by 30 years was too expensive.

Mortgage advisor Jeff Royle of iLender makes a good point about how smart people fall into these mistakes. Royle said that in the age of social media, so many people get their advice from podcasts and influencers, a variation of listening to the guy at the bar. That’s exactly what my clever friend did. He felt he could get all the advice he needed online without paying a financial advisor.

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