Why Our Brains Don’t Do Money and other Insights from Behavioral Finance

Ever since psychologist Daniel Kahneman won a Nobel Prize for Economics in 2002, behavioral economics has been a hot topic in the field of financial advice and wealth management. But how should customers understand these insights and use them to make better decisions? In this Tanager Talk, we put this question to Alan Newman, a psychologist with a focus on behavioral economics and consumer psychology. His observations may surprise you.

Alan begins by describing our brains’ two decision-making systems. System 1 is sub-conscious, fast, effortless and intuitive. System 2, by contrast, is conscious, slow, effortful and calculating. Economists, politicians and financial advisers have all traditionally assumed that most decision-making is based on System 2. In fact, it’s exactly the opposite. We use System 1 most of the time and most of the time it serves us well. Once you understand that, you think about advice and behavior differently.

Alan goes on to describe how the wiring of our brains, developed during the Stone Age, understands risk far better than money. While managing risk has been around forever in the form of escaping predators and searching for food shelter, money has existed for roughly 4,000 years which is  ‘nothing’ in evolutionary terms. One can see this play out in how our brains respond to different financial products such as credit cards versus pensions. Credit cards are brain friendly because the benefits are clear and the timeframe is ‘now’. Pensions, by contrast, are brain toxic. The benefits are not at all clear – governments keep changing the rules, they’re seen as complicated and they are a long way off. And because our brains are hard wired this way, they are not about to change anytime soon.

At the risk of becoming the Larry Summers of the podcast world, we next asked Alan if he thought women’s brains were wired differently from men. Alan believes that in the predominantly “pale, male and stale” world of financial services, gender-based differences exist that have a large impact on how women consume financial services. He illustrates the point by asking a question; “Who would you save from a burning building if you could only save one member of your family?” Consistently women opt to rescue a child while men tend to rescue their partner. Real differences in how women perceive risk and duties will necessarily have an impact on how they think about money.

Alan concludes the interview by showing how our brains subconsciously contextualize almost all decision making despite the fact that we live in a rules based world. You can hear all of Alan’s provocative views about how our brains work in a financial context by listening to the complete interview here.

Alan Newman is an independent consultant and Chairman of the Finance IT Network Ltd. He can be contacted via email at agnewman.is@virgin.net.

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