This morning I was in bed listening to chilly October rain pound my roof. Naturally, I wanted to stay in bed for another few minutes. And that’s when I realized it. Snoozing for five or ten minutes is usually a bad idea.
Like, a terrible idea.
It seems so innocuous at the time—five more minutes under your warm covers, cat purring by your feet. And yet even five extra minutes in bed can cause your morning routines to be rushed, make you late for work, and generally screw up your entire day.
Somehow, I then thought of this old picture of me in college wearing a paper bag over my head and holding a beer can. That picture is like “bad decision” illustrated. There’s the fact that I’ve obviously had a few too many, that I left somebody photograph me with a bag on my head, and the fact I’m drinking Coors Light. Ick.
But what do sleeping in and embarrassing college photos have to do with personal finance? Simple: They are examples of decisions many of us occasionally make—albeit poor ones.
And how well or how poorly one manages their finances generally comes down to a series of decisions. There are big decisions, like whether to go to college and what job to take, but there are also thousands of small ones, like whether to buy this or that on any given day.
Unfortunately, it’s really easy to make bad decisions. So I thought, let’s take a look at the anatomy of a bad decision.
How We Make Decisions
We make hundreds, if not thousands, of decisions every day. What route will we take to work? What will we eat for breakfast? What task will we do first at work? Some decisions are so routine, we don’t even think about them; our habits condition us to decide one way or another (bad habits, bad decisions).
When it comes to bigger decisions, however, the factors that may influence our decisions are so vast that psychologists spend their entire careers studying them. And we’re all different. Famous behavioralist Isabel Briggs Myers claims that we make decisions based upon our unique personality type. Even then, other factors may come into play:
- We may weigh the pros and cons of both sides
- We may make the decision by chance (flip a coin, cut a deck of cards)
- We may rely solely on intuition (our gut feeling)
- We may rely upon the advice of an expert or someone we trust
Why We Make Bad Decisions
One reason we make bad decisions is that we don’t consistently do any of the above. We don’t weigh both sides, listen to advisers, or even flip a coin. We just do what we want. And, usually, what we want means what we want right now. Instant gratification. We don’t think; we just do.
We want to sleep in, so we do. We want to drink too much, so we do. We want to spend instead of save, so we do.
Delayed gratification, it turns out, is actually hard work! In fact, we’re all naturally impulsive.
In a leading experiment on the science of self-control, scientists gave children the opportunity to have one piece of candy immediately or two pieces of candy if they waited a certain period of time. What they found was that almost everybody wanted the one piece of candy immediately. Unless the children were given something else to do that would take their minds off the candy. This “strategic allocation of attention” made it easy to forget about the potential for immediate reward while waiting for the delayed reward.
Interestingly, chimpanzees can do the same thing.
Bad Decisions and Risk Aversion
Some risk is good. Without it, we would live in world without entrepreneurs willing to bet their savings on a business idea, and without bankers willing to risk lending money to businesses and home buyers.
Sometimes we make bad decisions because we’re risk averse.
Imagine the woman who wants to leave her boyfriend because he doesn’t treat her well and doesn’t share her goals. She knows she needs to dump him, but on some level she knows she’ll miss him, she’s afraid of being single again. She’s thinking about the risks of leaving her boyfriend (regret, loneliness), even though the rewards (the chance to meet somebody better) are better.
Other times, however, being risk adverse can actually help us make better financial decisions.
The article The rich get richer and the poor get poorer: On risk aversion in behavioral decision-making discusses an experiment in which:
Fifty participants conducted a manipulated decision-making task in which one group gained money, whereas the other group lost money, followed by [a gambling task]. Participants who experienced a prior monetary loss displayed more risky choice behavior [gambling] than subjects who experienced a prior gain.
Although this seems counter-intuitive, it suggests that the less money we have, the more risks we’re willing to take to get a little bit more. The more money we have, the less risk we want to take to get a little bit more money. We want to protect what we’ve got.
I actually found this to be true of my spending patterns, too. When I was in the depths of my debt, I didn’t think much about continuing to overspend. Once I started to climb out of debt and actually had some cash in the bank, however, I started to become much more cautious about my spending because I wanted to preserve the money I had saved (and the progress on my debt).
The moral of this whole crazy story? You’ll never stop making bad decisions altogether (human fallibility interferes). But you can start making fewer bad decisions by:
- Approaching decisions rationally; listing pros and cons, and seeking expert advice
- Defeating impulsivity by improving self-control with “strategic allocation of attention” (distractions)
- Using appropriate levels of risk aversion to protect what you have
Will all this help me avoid the snooze button next time? Probably not. But it just may help me (and hopefully you) make better financial decisions when it really counts.
What do you think? Why do you make bad decisions—financially or otherwise? What strategies do you use to make better ones?
Earn and save more with our free course:
Join over 15,537 other young professionals. Get our best money hacks to get out of debt by 30, increase your income this year and invest for financial freedom.
100% free! I will NOT spam you and I will NOT share your email.