Why Smart People Make Big Money Mistakes

19 Oct

Why Smart People Make Big Money Mistakes - Book CoverDespite my general inability to get past page two of nonfiction books on topics like personal finance, I recently finished reading Why Smart people Make Big Money Mistakes: and how to correct them by Gary Belsky and Thomas Gilovich.

For brevity’s sake, and because time is short, I will refrain from a full review of the book. Rather, I will provide a few quick highlights that I found most personally relevant, and encourage you to read full reviews or even pick up a copy if you find these compelling.

To give quick context, the book is written from the perspective of behavioral economics, which studies the sociological and psychological reasons for our economic decisions. It makes a strong case that while many of us may think that we are financially savvy, that we in fact make many financial decisions due to social and psychological pressures rather than purely objective, rational ones.

The book outlines several fallacies and important lessons:

  • All Dollars are Created Equal: If you spend your bonus check or tax refund more easily than your regular salary, or if you invest your inheritance, retirement or education savings more conservatively than the rest of your portfolio (and are several years from needing these things) you are likely losing money.  A dollar of inheritance money has the same buying power as a dollar of your salary or a dollar from your lucky lottery winnings – so they ought all be spent or invested by the same criteria and consideration.
  • Loss aversion and the Sunk Cost Fallacy: Do you sell your “winning” stocks in order to lock-in the gain, but hold your “losers” in hopes that they will rebound?  Are you throwing good money after bad?
  • Bigness Bias: Would you not spend an extra $50 on your $200 domestic plane ticket to fly a specific airline, but don’t mind spending $100 extra to fly your preferred airline if its a $900 international ticket? Extra charges look smaller when they are wrapped into big purchases, but still cost you the same amount of money.
  • Ego Trap: Do you think that you can outperform the market with your smart stock picking techniques? Do you think that you’re doing pretty well with your investment return in the last year, but not actually know how much the overall market grew in that same time? You may not know as much as you think you do – the law of averages will beat you more often than you likely want to know.

See good reviews at Get Rich Slowly and The Simple Dollar.

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