I was speaking to a portfolio manager one day and he mentioned that after 40 years in the industry, a Chartered Financial Analyst designation, and after having managed hundreds of millions of dollars he was convinced that investing success basically all came down to psychology. I’m slightly less draconian, and cast a larger net, as I’ve always said that personal financial success is 90% psychology and about 8% math.
A few years ago Michael Shermer wrote an op-ed piece titled, “Why people believe strange things about money” and he lead that piece with a citation of research that indicated that more people would prefer to earn $50,000 per year when everyone else earned $25,000 as opposed to earning $100,000 per year when everyone else earned $250,000. We are asked to believe that the general prices of goods are the same in both possible scenarios, although this may be a bit of a stretch. That being said, essentially people would rather be relatively better off as opposed to absolutely better off. The math is simple. $100,000 is more than $50,000. But the psychological drivers at work guide the ultimate decision.
The field of behavioural finance is not new, but it is certainly expanding at a rapid pace. We learn all the math skills we need for our personal finances well before high school, but few of us ever really examine our decision making protocols coupled with the psychological influences we fall victim to. Luckily, we can start now and it won’t cost you a dime if you have an internet connection. Click here to watch all the lectures from “Introduction to Psychology” courtesy of Yale University on Academic Earth. Academic Earth is an aggregator of higher education courses and seminars that are made freely available to anyone who wants to “cyber-audit” them. No cost, but no credit either.
p.s. The missing 2% from the first paragraph is a testament to the relative unimportance of the math.
This content originally appeared in my Globe & Mail column
If everyone makes 250k, presumably prices of goods and services would reflect that. In that case, wouldn’t earning 100k be relative poverty? It makes sense to me that one would strive to be above, rather than below the average.
@flanaganmdp Agreed, but the study apparently controlled for that and was trying to tease out the drive between relative and absolute standing. But simply telling someone that prices are the same in each scenario: I don’t know if someone put that question to me that I would be able to factor out the basic principles of supply and demand. I think I would choose $50,000 because I believe prices would have to change. If there was a guarantee that prices would be no different, then I would choose the $100,000. But how the heck would you guarantee that? :)
As A Financial Planner I see the end results of this daily. I just turned 40 and was speaking to 6 others in a similar age group. They were asking where they should be financially ie. RRSPs, mortgage, RESPs etc. I was saying based on our similar incomes (I know these guys pretty well but I don’t manage any of their portfolios) a good yardstick would be to have $100000 roughly in their RRSPs, mortgage 1/2 done and maybe $5-10K per kid in RESPs. They were almost all shocked and felt I was being unrealistic. Digging further most had little to none saved and the basic response was I can’t achieve that so why should I even try. They give up before they even start. Their attitude is fatalistic yet optimistic that it will work out in the end. I have been thinking more and more about getting a degree in Psychology so I can understand my clients!
@Iam_Canadian So true. I found that my wealthiest clients did a few simple things really well: spent less they earned, didn’t like debt, and that was about it. You master those two things, and the world really opens up for you.