S2E8: 7 ways your brain is making you poorer | David Robson
Smart people make bad decisions all the time. That’s because intelligence (IQ) has no bearing on our ability to make rational, unbiased decisions. If you can be aware of your biases and investigate your intuitions then you will make better decisions which can have a profound effect on your finances. In this episode, David Robson, author of The Intelligence Trap, lays out the key biases stopping you from getting richer - and how to combat them.
Things to remember from this episode
David Robson is the author of The Intelligence Trap, and he argues that making good financial decisions (and decisions generally) is not just about how intelligent you are, it’s whether you apply your intelligence.
What is intelligence? Well for the last 100 years, it has meant generalised brain power - which we measure through an IQ test. This correlates with academic achievement.
But the latest research shows generalised intelligence doesn’t predict a lot of important things like decision-making in the real world, or how we form beliefs, e.g. intelligent people believing fake news.
Research now shows we should be considering different forms of intelligence and traits.
Robert Steinberg came up with a test which evaluated different forms of intelligence: analytical intelligence (basically IQ), practical intelligence and creative intelligence. You need different types of intelligence to be effective - e.g. you need practical intelligence to work with people and get stuff done. EQ would fall under practical intelligence in this framework.
Biases affect people however intelligent they are (measured by IQ).
There’s no real science showing that people who are smarter are less likely to get into bad debt.
Hardly anyone reports being a victim of fraud because people are ashamed of it - what it says about them and their intelligence.
Context is really important, e.g. when you’re feeling emotional. You’ve got more chance of being scammed when you’re vulnerable.
We often struggle with biases when we use heuristics - basically intuitions or short cuts - rather than thinking something through properly. This is sometimes called being a cognitive miser - being miserly with your thinking.
Warren Buffet says investing is all about temperament. He keeps a diary of all of his decisions, good or bad. This is basically a cognitive autopsy - applying and learning from his experience of his own biases.
Do you have a fixed or a growth mindset? Having a growth mindset means you think your abilities grow over time (you can learn from your mistakes) - whereas fixed means people who think all their abilities are innate and fixed.
7 cognitive biases
Cognitive biases are systematic errors in our decision-making, like anchoring. You hear a number which then affects how you value something - e.g. if you’re shown a product with a high price, you’re more likely to pay more for the next product you see. This bias often comes into play when buying or selling a property. And it’s one of the reasons a three-tier pricing system is effective.
Sunk cost bias (or fallacy) - if we’ve invested a lot of time or money into something we are more likely to stick with it and keep putting in more time/money even if it will cost us more than stopping and using our time/money elsewhere. This can affect investments, of course, or entrepreneurs sticking with a losing idea for too long.
Loss aversion - we hate the possibility of losing. This means we can make illogical decisions, especially not taking risks when the odds are overwhelmingly in our favour. You can see this in people who keep too much money in cash, as they’re worried about losing it, even though they are effectively losing it to inflation.
Motivated reasoning - we come to a belief and then really want to protect it, so will create arguments/explanations/rationale to defend why we’re right. Intelligent people can be even more susceptible to this bias because it’s easier for smart people to form reasonable justifications and dismiss opponents.
Exponential growth bias - people really struggle to visualise exponential growth, so struggle to understand the value of compound interest, for instance.
Curse of expertise - if you’re knowledgeable, you can make worse mistakes than a novice. This basically comes down to dogmatism. You stop listening to other people’s views - getting entrenched in your own.
Group think - this is where we go along with the group (and what they think) because we instinctively fear being excluded.
How to combat your biases
Performing a cognitive pre or post mortem can be useful, so you can learn from your decisions and the biases that affect them. To do a pre-mortem, imagine the worst possible outcome from a decision and look at all the potential errors that could lead to that outcome. Try to find data to evaluate whether something is likely or not. This helps stop you from being a cognitive miser.
Try to develop your emotional intelligence to analyse your intuitions more rationally. You’re basically trying to be more emotionally literate so you can pinpoint your exact emotion and where it comes from. Having a big vocabulary of emotional words is useful here - not just words like ‘happy’ or ‘sad’. This helps you tap into your intuitions so you can trace the source of them.
This means it’s generally useful to assess your emotional headspace before making a big decision, financial or otherwise.
Intuitions can be very useful - if you investigate them - where do they come from and what do they mean? To do this you want to practise self-distancing and there are several techniques. You can imagine your friend is facing the same decision - what advice would you give them? Or you can ask how you will feel about this decision in the future in, say, 10 years. Sometimes talking to yourself in the 3rd person can help. And you can also speak in a foreign language, known as the foreign language effect.
Emotion triggers biases so you want to strip emotion out of decisions, particularly financial ones.
Something we often forget to do when making decisions is imaging different scenarios.
David suggests being aware of your biases, your emotions - and to think things through.
