Behavioral psychology in a nutshell - how to make the best personal choices, be wise with ambition and have the best mentality towards money.

A crisis is an opportunity riding a dangerous wind.

Chinese proverb

This blog is focused on how to have the best mentality towards money via wisdom.

Trust your instinct - don't get lost in statistics

Starting with an anecdote, French race horse trainer, Franck Mourier worked as a tipster and reputedly selected his horses to bet on sometimes solely based on instinct, not even knowing why logically his horse was best and having mathematically figured out beforehand that horses odds were low. He did this only after watching the runners for a few minutes before a race. In other words, he followed his instinct and gut feeling, and regularly did best.

He commented - 'How can I pretend to know that horse A is going to run a mile one-tenth of a second faster than horse B, just by looking at them for a couple of minutes before they run? It doesn’t make any sense to me, but somehow it consistently works! The margins between winners and losers are always terribly slim. So how is it that my predictions can be so accurate – consistently better than everyone else? It creates a terrible discomfort'

I think trusting your gut instincts, your dreams, your overall feeling is a crucial move to make when managing personal finances. Don't just be ruled by your logical side of your mind. Stay emotional and stay open-minded.

Make the most of urgent situations and panic

If there is an urgent situation and you can provide a service that helps those urgently in need of that service, there is a great chance you can make a high mark up and profit generously for the time you put in the work.

Equally if dealing with speculation and you are confident in a stuttering stock for instance, then to buy at the opportune time would be to buy when confidence is low and the stock is falling.

Relative Income and the Easterlin Paradox - A preference of status over more wealth? Be wise with ambition.

When Sara J. Solnick and David Hemenway conducted a survey to 257 faculty students and staff at the Harvard School of Public Health about their view of their position, relative to others, they posed the following question: which would you rather?

'Option A: Your current yearly income is $50,000; others earn $25,000.

Option B: Your current yearly income is $100,000; others earn $200,000.'

Roughly 50% of respondents preferred Option A. in which they had half the real purchasing power given that their relative income position was higher. These were people from Harvard giving their honest answers, so the survey was hardly a demonstration that people are of low intelligence. It does though sadly show people are more competitive than they are altruistic when it comes to income. More to the point it shows that many want to be towards the top any relevant hierarchy before being affluent but relatively unimportant - bigger fish in smaller ponds so to speak. The final rational reason for picking Option B is the ability to acquire positional goods, coined by  Fred Hirsch. For example, purchasing a house with a good view depend more on relative income than absolute income (as its harder to do in London and Paris for instance than in a lower-income city).

This study defends the polemical Easterlin Paradox, which states in the long run, a sense of well-being within a country does not go up with income. Richard Easterlin, then professor of Economics at the University of Pennsylvania, was known for being the first modern economist to study happiness data in high depth. He studied happiness surveys conducted in 19 countries, developed and less-developed, after the Second World War, to see what evidence there was of an association between income and happiness and found that in general whilst higher incomes are associated with higher levels of happiness within a country, average levels of happiness for a country do not appear to increase over time in line with increases in average income; nor were much more affluent countries much happier than their poorer counterparts. In other words, the rich are happier than the poor, but there is evidence that countries average happiness levels do not rise as the countries citizen's get richer.

A reason why the Easterlin paradox is so heavily argued is that research shows that happiness tends to fall in economic contractions and rise in expansions; however numerous studies have accepted that in the short-term happiness and income generally correlate whilst in the long term they rarely do or don't; defending Easterlin's hypothesis and the age-old cliche that happiness cannot be bought (at least in the long-term sense).

Will-Power, Self-Control and the explanation for Failed Resolutions.

Will power requires self control and good time and energy management skills are crucial for preserving this power, as accurate decisions require slow thoughtfulness. Kahneman percieved that there were two ways of thinking in principal, which he calls system 1 and 2, but could be roughly translated as fast and slow - the title of his book. System 1 is responsible for involuntary actions of an individual and operates automatically: essentially purely subconscious, always active, fast and relatively mistakeful; System 2 meanwhile enables an individual to work on complex problems more successfully and is relatively voluntary, dependent on a person's willpower and mental focus.

To illustrate how we use both, think of the question - 'A bat and ball costs £1.10. The bat is £1 more expensive than the ball. So how much does the ball cost? The price that comes to mind - £0.10 is 'the result of one emotional and automated system, and it's working' according to Kahneman, though the correct answer :£0.05 is relatively easy to figure out if a few more seconds are spent solving the question.

Will-power (and system 2) is a muscle that tires and therefore, must be preserved for a person to maintain self-control through conscious healthy habits, such as sleep and correct mental priming/conditioning (not over-working for instance). Otherwise, our system 1 will sabotage ourselves through self-deception, auto-pilot and bad habits. To illustrate this, think of two well known phenomena: first, consider the data on New Year Resolutions which research shows rarely (only 10-15% of the time) ever succeed, with a considerable number of resolutions (aprox 40%) not even lasting beyond January. Also, consider how common yo-yo dieting is, when a person initially and often over-enthusiastically loses weight, only then for his or her discipline, will-power and motivation to susquently plummet, leading to a relative rapid regression and gaining of weight. The answer is that will-power seems not to not be people’s strong suit, nor does long-term self-control.

Kahneman writes 'self-control is cognitive effortful work of system 2 that requires attention resources… Ego-depletion is the loss of the ability to engage in self-control.. As cognitive activity increases, so does selfishness (parole judges data show tired and hungry individuals make poor choices)…' This means the mind needs rest and enjoyment. Will-power is not about self-deprivation but self-control, which is in fact it is the opposite - more about respecting your choices and being realistic.

References

(1) Thinking fast and slow, Daniel Kahneman, 2012