Common sense about money and life
and why it makes no sense at all
In this Insight, I’ll explore the evidence on how common sense (and other normal human behaviours) can cause our biggest mistakes – both with our money and, more generally, in life.
And, of course, I’ll offer you some ideas for dealing with this fact.
Chunky Insight: 5 to 15 minute read, depending on your speed
If you’re fascinated by the new science of human behaviour and the array of mental shortcuts and cognitive biases that mess up our day to day decisions (on money and life), this Insight is for you.
Do you take mental shortcuts?
Well, I can tell you upfront, we all use mental shortcuts all the time – and they don’t always serve us well.
If you’re not familiar with the science of human behaviour, a great place to start is with the Dunning and Kruger effect, which describes a dangerous behavioural flaw that many people share.
What David Dunning and Justin Kruger found was that many of us, when we have low levels of skill in any particular area, over-rate our abilities.
In these situations, our extraordinarily biased view of our skills and knowledge is, it seems, caused by our inability to recognise our own mistakes.
[See ‘Unskilled and unaware of it: How difficulties in recognising one’s incompetence lead to inflated self-assessments’ by Kruger and Dunning.]
Indeed, it turns out that having a reasonable level of competence can actually weaken our self-confidence!
Once we acquire a particular skill, we wrongly assume that others are at equal or higher levels.
This image illustrates the effect well.
If you know the creator of this image, please let me know so I can give credit.
And, if you prefer words to graphs, you might like to simply place people, for a particular skill or area of knowledge, into one of four groups:
- those who know and know they know
- those who know, but don’t know how much they know
- those who don’t know much and know they don’t know
- those who don’t know, but think they know it all.
Please be aware, group 4 is a large and dangerous group!
Of course, we all get overconfident occasionally, and it’s worth looking out for those moments to put a lid on the trouble it can cause.
Even if we’re not ordinarily overconfident, the chances are that we still take a lot of mental shortcuts (aka heuristics to Psychologists) in our day to day decision making. And these can result in significant errors of judgement.
These brain-warm-up exercises will give you a feel for what I’m talking about. They’re taken from (part 2) of my first book, ‘Who can you trust about money?’ in which I explored various ways in which we mislead ourselves about money – without any outside help!
Part 1 of that book, BTW, explores how others mislead us.
Try these exercises now:
Exercise 1 – Paris in the springtime
Look at this picture and read what it says, aloud.
Okay, now look at it again.
Notice anything strange?
Okay, well look at it very carefully just one more time then.
See the issue now?
We all miss it initially.
Try sharing it with a friend to see how fast they spot it.
Exercise 2 – Only smart people can read this
Try reading this quickly.
Isn’t that amazing?
Something quite different is happening now.
While the previous exercise revealed our tendency to ignore details, this one shows how we’re capable of rearranging reality. So, we get to read what we expect to see rather than what’s written.
And we achieve this incredible feat of interpretation with only a quick scan of whole sentences.
Frankly, it makes me question the need to have my books and blogs edited!
This ability to interpret things quickly is a great asset, and not just for reading silly error-filled sentences!
In more competitive and threatening environments, it improves our performance and can even save our life.
Think about crossing a busy road. That requires quick decision-making to avoid oncoming vehicles, right?
Such survival skills have evolved over hundreds of thousands of years too.
Imagine you were an early human living on the open savannah and spotted what you thought was a lion sitting in the long grass.
You wouldn’t have survived very long if you stood there staring and making a detailed analysis of the lion-like image before deciding it was a lion and running for your life.
So, the process of natural selection has hardcoded these skills into our brains.
This tendency does, of course, result in a lot of judgement errors too. We’ve all misinterpreted innocent shapes as threats to our safety, right?
Faces in the shadows or at the window. And yes, we’ve also felt silly when we realised our mind was playing tricks on us, but that’s undoubtedly a small price to pay for having a mind that’s always on the lookout to keep us safe.
However, this tendency to jump to conclusions (based on incomplete and messy information) can be very dangerous when we’re dealing with more complex ‘big cat’ decisions around money and life.
Decisions on this stuff need us to switch on the analytical side of our brain*
* Yes, we also need emotional engagement to improve our life goal thinking, but that’s a subject for another time 😊
So, let’s try a few more puzzles to make sure your brain is properly warmed up.
This next one should only take a few seconds if you remember to engage the ‘thinking’ side of your brain.
Exercise 3 – The bat and ball riddle
A bat and a ball together cost £1.10.
The bat costs £1 more than the ball.
How much does the ball cost?
That’s not difficult, is it?
What answer did you get?
Are you sure about that?
Try asking a friend to see what answer they get.
And finally, here’s my favourite number riddle of all time
Exercise 4 – The same birthday question
There are 30 children in a class.
What are the chances (approximately) that at least two of them have the same birthday?
(You can assume their birthdays are randomly distributed across the year)
Where to find the answers
You can find the answers to these and many more questions in my book, ‘Who can you trust about money?’
And YES, you can have them for FREE if you sign up to my newsletter and e-mail me on email@example.com with the message ‘riddle answers please’.
Do that and I’ll send the answers to you, as soon as I can.
The answer to the ‘same birthday’ riddle is particularly intriguing and stuns most people when they learn it. The correct answer is just so vastly different to anything you’d expect.
What can we learn from this?
Well, the lesson here is not about how to work out the answers – interesting though that is!
The lesson is about seeing how completely useless our intuition and ‘gut feelings are when it comes to solving complex problems.
The fact is, it’s difficult for us all (including highly intelligent and well-educated people) to slow our minds down and focus on problem-solving.
Our brains are energy-saving devices. So, they try, wherever possible, to skip hard work and jump straight to (what appear to be) the obvious answers.
By the way, if you resisted that temptation, got all the right answers and you think you won’t learn very much here, stick with me a while longer.
In the examples coming up, you’ll see how the normal human behaviour of even the world’s greatest minds, can lead to massive money mistakes.
Developing an awareness of this tendency (to jump to conclusions) is critical if we want to learn to solve slightly more complex, real-life problems – including those around our financial future.
After all, it can get a bit complicated to work out how much we need to save in order to build the funds, we need:
- In today’s money terms
- For our various life and retirement goals, which
- Arrive at different times
- Assuming our money earns different rates of investment growth and
- Taking account of the varying rates of tax in different tax wrappers.
So, we might need to give this some close attention… though if you learn from the right person, we can make that task easy too!
Okay, but what about common sense?
Now while mental shortcuts and rules of thumb, do let us down on complex problems, I’d not go as far as George Bernard Shaw, in damning their use.
Shortcuts and rules of thumb can be helpful, in some situations, some of the time.
The world is just too complicated, and our brains too limited, to run a rational, multivariable analysis of every little decision we make.
Take choosing a product to buy online, for example.
Looking for ‘likes’, while not a guarantee of quality, works most of the time (at least on established products) and saves us a lot of product analysis time.
We just need to know when, and on what questions, to stop taking shortcuts and stop ‘trusting our gut’.
Getting this wrong can be enormously costly.
So, a good rule of thumb is to avoid rules of thumb 😉 and common-sense guidance on any big life decisions.
Not sure about that?
Okay, well, take a look at this short list of proverbs:
- Never look a gift horse in the mouth
- Don’t cross your bridges before you come to them
- Better to be safe than sorry
- Money can’t buy you love!
Now, you might think that’s all super-useful, common-sense, guidance which has stood the test of time, right?
Well, no, the astounding truth is that for all of these (and most other) common-sense sayings, we can find another one that offers precisely the opposite advice!
Still don’t believe me?
Take a look:
‘Never look a gift horse in the mouth’ – is entirely at odds with – ‘Beware Greeks bearing gifts.’
‘Don’t cross your bridges before you come to them’ – argues with – ‘if you fail to plan you plan to fail.’
‘Better to be safe than sorry’ – suggests a very different strategy to – ‘nothing ventured nothing gained.’
And, the funniest of them all, ‘Money can’t buy you love’ is, I think you’ll agree, very much at odds with the evidence… never mind the fact that it conflicts with another proverb saying that:
‘when money goes out the front door, love goes out the back.’
This table offers many more examples.
Summary, so far:
Instead of worrying, as Voltaire did, that ‘common sense is not so common’, we should hope it becomes less common – because ‘common sense makes no sense at all.’
A more money-specific example of a common sense bias that can cause serious financial problems would be where we hold to a belief that ‘Pensions are a costly waste of time.’
Sadly, this commonly held bias is regularly reinforced by the way pensions are covered in the Newspapers.
Our real challenge then, whether we’re biased towards a way of life, against a group of people or even a specific financial product (like pensions!), is to overcome our biases when we (and others) are continually working to confirm them.
Confirmation bias – the evil enemy.
Confirmation bias describes our tendency to seek out information to confirm our existing beliefs and dismiss ideas that challenge them.
Know anyone who does that – or rather, know many people who don’t?
Most of us display this bias at times, and it’s understandable too.
It’s unsettling to challenge our own beliefs, never mind discard them, particularly if we invested heavily into them, either with a lot of our time, money, or both.
Beliefs, however irrational and disproven by science, like those of the creationists and flat earth brigade, are not given up easily.
Yet, if we want to play our part in human progress and develop our skills for the future, we have to challenge our current knowledge and beliefs.
Steering clear of chummy, tribal echo chambers and (less friendly) flame wars on Social Media, will certainly help us with that.
The noisy activity in the left and right zones of this picture is driven by people’s desire to conform, confirm and defend their existing beliefs. So it’s utterly worthless.
There is very little learning going on in those zones, and I recommend you stay away from them as much as you can. Aim, instead, for more productive discussions in the valley of open-mindedness!
How NEW is the science of human behaviour?
I suppose behavioural science is relatively new, given that the academic analysis only really got going in the 1950s with Herbert Simon, who later won the Nobel Prize in Economics. His work spanned everything from cognitive science, computer science, management and political science.
However, observations about the flaws in human behaviour and thinking, have been made for thousands of years. And set out below are just a few examples of the many hundreds we could have chosen.
This first quote is from the Greek philosopher, Heraclitus, who a very long time ago, was keen to correct this commonly held but mistaken belief.
I chose this one because I think we might need reminding now, of the fact that we cannot go back and re-live a life from the past.
We’re surely transitioning to a new world after, (or with) Coronavirus. Should we seriously expect it to look just like the old one, rebooted?
Next is Galileo who also noted a classic human behaviour error, of making false assumptions about other people and missing out on their valuable ideas.
How often do our biased views about the ‘worth’ of other people, cause us to ‘tune out’ when reading or listening to what they say?
Also, how often do we ‘tune in’ (way too far) to the thoughts of our favourite ‘gurus’ or other famous people.
Hanging on a guru’s every word is a risky strategy as I outlined here.
Blaise Pascal, the Mathematician, was deeply concerned about our tendency to be impatient and our preference for action versus thinking which, he felt, was the cause of most of the worlds’ problems.
Can’t say that I disagree with that!
Then there was the English poet Alexander Pope who, in his essay on criticism, identified the Dunning Kruger effect long before modern-day psychologists.
Smart people make thinking mistakes too
You’ll also be familiar with Isaac Newton, one of the greatest of all Scientists, who developed Mathematical Calculus, the Theory of Gravity and much more.
But did you know that he discovered his own irrational behaviour when he followed a herd of investors and bought shares in the South Sea Company?
Unfortunately, he bought up a lot of those shares during a bubble in their price – and lost a great deal of his wealth, when that bubble burst.
And when Charles Mackay catalogued the ‘South Sea’, and various other speculative manias, he observed that:
Finally, in this short, list of observations on human behaviour, we have John Maynard Keynes, the widely acknowledged and brilliant economist, who also learned how ‘markets can be irrational, for longer than you can remain solvent’…
when he blew up his finances (twice) in the ‘roaring’ 1920s.
If you’d like to learn more about the various financial crashes in history, there’s more detail in my book, ‘Who can you trust about money?’
Alternatively, you can go even deeper into financial history with John Stepek’s new e-book on past market crashes. I think that book is on offer to subscribers of Money Week, but you can check that out directly with John Stepek (the Money Week editor) here. He’s worth a follow.
Also, if, like me, you love to read brilliant Insights on what matters in life, take a look at these other quotes I pulled together on the subject of science and truth. You’ll find some absolute gems in there.
So, brilliant people like Newton and Keynes were clearly not immune to making bad investment decisions.
Whether their biases included a belief that they were smarter than other people, I can’t say, but on other matters, they were.
Or maybe they were simply at a disadvantage to us because there was very little science published on human behaviour in their times.
After all, it took Herbert Simon (in the 1950s) and Daniel Kahneman and Amos Tversky in the 1970s to move the science of human decisions on.
So, might Newton and Keynes have avoided their errors had they known something about the new behavioural science?
That seems unlikely.
As Daniel Kahneman, Nobel laureate (and father of behavioural economics) said, in September 2018,
“You can’t improve intuition.
Perhaps, with very long-term training, lots of talk, and exposure to behavioural economics, what you can do is cue reasoning…
Unfortunately, the world doesn’t provide cues. And for most people, in the heat of argument, the rules go out the window.”
This is not to say that we’ve given up trying to overcome our biases. A recent study suggested that some training can reduce confirmation bias to some extent. I’m just not aware of evidence that we can reliably and substantially reduce the effect of biases on our personal decisions.
Our biases, it seems, just show up, uninvited, in our unconscious minds. We’re simply not aware that we use them in our day to day lives – to decide on specific actions, or when we form biased views on the worth of other people.
Knowing about thinking errors doesn’t reduce ours!
This much we know from Daniel Kahneman’s statement above. And it’s not surprising when you consider the challenge we face with our cognitive biases. It’s not just that they sit in our unconscious mind, it’s because we have to cope with such a vast array of them too.
Just look at them all here – as wonderfully laid out in this image by Buster Benson and John Manoogian – follow this link for a high definition chart.
It’s simply not realistic to believe we can avoid falling prey to all (or even most) of these biases throughout life.
However, if we look again at what Kahneman said,
‘For most people, in the heat of argument, the rules go out the window.’
It seems there might be strategies we can use (not to eliminate our biases) but to reduce the risk of them leading to big money mistakes; strategies to take the heat out of our decision making.
Taking the heat out of decision making
When it comes to improving our performance in any area, a good coach can offer enormous benefits.
Bill Gates, the founder of Microsoft, once said
Everyone needs a coach. It doesn’t matter whether we’re a basketball player, a tennis player, a gymnast or a bridge player.
We all need people who will give us feedback. That’s how we improve.
Eric Schmidt, CEO of Google from 2001 to 2011, said,
Every famous performer has a coach. Somebody who can watch what they’re doing and say, ‘is that what you really meant?’
A coach gives you perspective – and that’s the one thing none of us is good at – seeing ourselves as others see us. So a coach really helps.
Financial planning is not vastly different, in my view.
Indeed, you might argue that coaching on your financial planning is more critical than in your other endeavours.
You’re unlikely to engage with this subject very often, and certainly less often than you might play at golf, tennis, the piano, or (insert your interest here)
So, most people tend to be ‘rusty’ all the time, on issues around money.
And being rusty at financial planning, (like being a pilot) is a risky state to be in, on your own.
A competent coach will empower you to free think your future, explore your realistic financial choices, map out your plan and adjust it when you need to.
Critically, a great coach will give you space and time to think carefully about the key issues. That takes the heat out of your thinking and should help you make decisions that work better for YOU.
More thoughts on what to look for from a coach here
Learn the basics before you pay for advice
There’s no question that an excellent financial coach/planner can add enormous value to your financial life.
The only trouble is, these people are difficult to find; they don’t tend to advertise because they’re sought after and busy!
And, for the same reason, they’re not cheap either.
So, I’d suggest that the best value first step for most people, is to learn the fundamentals of financial planning and start mapping out a plan for yourself.
Indeed, even if you can afford a coach or adviser, I’d suggest you learn the basics around money, investing and pensions for two reasons.
First, so you can tell whether the advice you receive is broadly sensible.
And second, so you know if what you’re paying for it, is good value.
Don’t assume all advisers are the same.
Fee levels and advice quality varies a lot.
Learn financial planning? Is he serious?
Well, yes, I am.
Yes, I realise that most people are ‘biased’ 😉 to assume that this is all very complicated… but the truth is, for most people, it’s not that difficult to learn the fundamentals.
What’s more, learning what you need to know can be fun too – with the right tutor of course 😊
The big mistake you must avoid is following any of the misleading nonsense you’ll find in a great many books or online blogs or videos.
Not just because you might end up in a dangerously confident place with very little knowledge, as the Dunning Kruger model suggests. It’s also because you’re very likely to be grossly misled by a lot of that stuff.
I can’t even begin to tell you about all the different ways people might mislead you about money.
Oh, wait, yes, I can…
I wrote a highly acclaimed book on exactly that.
Okay, but how might you focus your learning?
Well, as a minimum, you need a robust way to draw up your financial life plan, which takes a proven and evidence-based approach.
So, with a diploma in Financial Planning, I’ve been careful to align the approach I recommend to people, with that of the financial planning profession.
This way, you can start your plan on your own, with my process, knowing you’ll be on the right track if you decide to employ a financial adviser down the line.
Make a good start on this, and you could save yourself lots of time and money whenever you need to have dealings with the Financial Services Industry.
Your processes for planning also need to be engaging and simple enough, for you to want to work through them.
Behavioural science is clear on this.
We vastly improve our chances of developing new skills and habits (whether to manage our wealth or our health better) if we approach our challenges in small steps.
That’s why I developed this money mapping exercise, to help you visually connect your money to what matters in your life – your goals for yourself and your loved ones.
You can probably see that, without any training at all; you could start to map out your financial life goals in a picture like that, right?
That was my money life map, from *several* years ago, by the way.
What would yours look like today?
The bottom line
You need to use robust processes to plan your money and choose the right boxes for your savings and investments.
These processes should help you to sidestep some of those natural but irrational human behaviours we all have.
And if they’re easy and fun to use, you’re more likely to stick with them.
That’s a whole lot better than giving up, throwing caution to the wind and making those fast, (and often risky) decisions, right?
Hope that all makes sense.
Want to learn more?
I know this was a long read, but I hope you found it interesting and potentially helpful, either to you or to someone you care about.
If you’d like to learn more, sign up to my occasional newsletter.
I’ll then send you my 5-steps to financial freedom starter pack and the first chapter of my book, ‘Who misleads you about money?’
I’ll also update you on future key Insights like this (and a lot shorter!) and a whole series of lessons I’m planning to help you gain:
- More control of your spending, if you need to.
- More control of your plan – for your future financial life.
- More control of the risks your money is exposed to
- More control of your adviser, if you have one, and more control over what they charge you too!
I’m also working on lessons (on sales, marketing and project leadership skills) to help you gain more control of your success and earnings at work too.
After all, what use is a financial plan, if you don’t earn enough to fund it?
Please let me know, in the comments or by e-mail firstname.lastname@example.org if you believe this could be useful to you. I’m genuinely keen to know!
PS to Financial Service business leaders
Feel free to message me to arrange a chat if you need help in creating (or enhancing an existing) financial education programme.
I can help with strategy, idea development or content creation* and can help you achieve *that* in a super-efficient way too.
Alternatively, if you’d like me to run a fun and interactive learning talk on this sort of content, or anything else I’ve written, let’s talk about that. I’m currently taking bookings for October.
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