Clever people can make bad investment decisions

Do clever people make better investment decisions?

Don’t be fooled into thinking that just because someone is considered to be clever, that they will make great investment decisions. In fact, it could be quite the opposite – many an intelligent person has made some really bad decisions over time.

Part of the problem is the concept of intelligence – this is generally measured by IQ tests, and these tests only capture analytical intelligence – in other words, the ability to notice patterns and solve analytical problems. They don’t consider other forms of intelligence, namely our ability to deal with novel situations (creative intelligence), and our ability to get things done (practical intelligence). The educational system is built largely around analytical intelligence, and we often encounter highly intelligent people who are uncreative and not practically minded at all.

Professor of applied psychology at the University of Tornonto, Keith Stanovich, has written several books on cognitive behaviour. He has found that intelligent people tend to make more mistakes than those of average intellect on logic problems, because they tend to take shortcuts or make assumptions.

They may be over confident or under value the importance of effort, and, combined with greed, pride, stress and even laziness, can result in poor decisions being made.

Time is often an issue, and viewed as a luxury. As humankind has evolved, certain decisions have become automated, and our brain recognises these patterns and makes the decision. Where emotions are involved, we make faster decisions and jump into action. Think of a mother with a new born baby. When the baby cries, her brain, driven by instinct and emotion tells her to go and pick up the baby – it is automatic – she doesn’t even think about it.

Quick automatic decisions may be a lifesaver when it comes to self preservation, but if a situation requires rational thought, jumping to conclusions can have the opposite effect.

It is also almost impossible to separate emotions from decisions, and our state of mind at the point of decision making will play a major role. The more pessimistic we are feeling, the greater we will want to conserve what we have. If we are in a high spirits, we might make a more daring decision, taking a greater financial risk, as the future seems bright and full of promise.

Just think about when people get their annual bonuses – they feel rich. They are flush with money, so they spend. From an investment perspective, a good mood, and a feeling of positivity about life and the future would encourage more risk taking, as things can just be good in the future.

Compare that to someone who has been retrenched and has received a severance package which they need to invest to provide an income, until they find employment. Their mood and outlook for the future will be far more conservative. Their investment decisions would reflect this.

Investment decisions are always made in the context of life. Money is about people and their lives at the end of the day. Intelligent people don’t necessarily make the best decisions, and the same can be said for people in a highly emotional state. With investing, there are no guarantees but there is also no substitute for objective, professional advice. It cuts through personal biases beliefs and fears, and gives an objective unbiased perspective – something worth building an investment strategy on.

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