How to Make Better Financial Decisions: Part 1

Lessons from Daniel Kahneman

Daniel Kahneman passed away earlier this year. The professor of psychology won a Nobel Prize in economics for a lifetime of research on how humans make decisions, good and bad.

Much of our financial planning work is not about determining the right financial steps. Despite temptations to veer off course, it is about helping people do what we and they know is right.

Over the next few weeks, we'll apply Kahneman's key findings and show how they can help you make better decisions. His book Thinking, Fast and Slow is a spectacular read if you want to learn more. If time is short, these blogs will provide his key lessons.

These three takeaways are at the forefront of decision-making:

Human decision-making is an uneasy interaction between two fictitious characters: System 1 and System 2. System 1 is automatic and lightning-fast, with little or no effort. It drives much of what we do, from spotting threats to understanding simple sentences or detecting that one object is farther away than another. System 2 makes complicated decisions and requires effort. When we think of ourselves, we identify with System 2, the conscious and reasoning self that has beliefs and makes choices.
We need System 1 to survive, and for many decisions, System 1 does the job perfectly well. Imagine being threatened by a poisonous snake; if we don't react quickly, we can die. However, to make more complicated decisions, we need to stop and let System 2 work.
Because complicated decisions require effort, we are tempted to take shortcuts or make knee-jerk decisions. The result is often a bad decision. Many shortcuts are known as heuristics - a simple procedure that helps find adequate, though often imperfect, answers to difficult questions.

Over the following blogs, we will discuss heuristics and biases that prohibit good decision-making. These include: