Our brains are wired to make poor financial decisions

Money often feels more emotional than logical. Studies show that thinking about money activates brain areas tied to reward and motivation, sometimes leading to irrational decisions. This makes managing money challenging for most people.

Financial psychologist Daniel Crosby explains that working with an adviser or automating saving and investing processes helps reduce stress and poor decisions. Research by Merrill Lynch found that behavioural coaching—helping clients avoid emotional mistakes—adds far more value than stock picking or tax strategies.

In this short video, learn why the key to better financial outcomes isn’t finding a stock market wizard but building a strong rapport with an adviser who acts as a behavioural coach. Discover how this relationship can protect you from your worst impulses and lead to long-term financial success.

Key takeaways

Behavioural coaching provides the greatest value by helping you avoid emotional and impulsive financial decisions.

Most people mistakenly seek advisers for investment picks, but real benefit comes from guidance on behaviour and mindset.

A good adviser relationship requires strong personal rapport to motivate you through difficult but necessary financial habits.

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It’s certainly not the only key component of a good financial plan, but having an efficient investment strategy is crucially important. For insights into optimal investment methods, backed by peer-reviewed academic evidence, we highly recommend subscribing to The Evidence-Based Investor.

Transcript

Robin Powell: We like to think we’re logical and unemotional when it comes to money. 

But neuroscience tells a different story.

Studies have shown how even thinking about money activates areas of the brain linked to reward and motivation.

In short, we get more excited about money than just about anything else — including politics and even sex — and that can lead to irrational decision-making.

Daniel Crosby: Understanding how sort of bent out of shape we become about money. I think it is a recipe for offloading it. Either working with an advisor or fully or nearly fully automating the process by which we save, spend, and invest is one of the best things we can do. 

RP: Because the less we think about it, the less bent out of shape we're going to be. 

In 2016, Merrill Lynch conducted a meta analysis of the value a financial advisor adds. In other words, it combined the results of multiple studies on the subject. Here’s what it found.

DC: First of all, everything that an advisor does for her clients is additive. But things like fund selection were just a little additive. They added about a third of a point, about a third of a percentage point of value per year. 

Same thing with, like, tax management strategies added about one third of a point of value per year. 

But if you looked at what we would call behavioral coaching, which is keeping that person out of their own way, preventing them from making a giant mistake, preventing an emotional contagion from wrecking the way that they go to market. That added nearly 2.5% per year of added value. So it's about eight times as additive. 

RP: So it’s behavioural coaching that adds by far and away the most value. 

The irony is, that's generally not what most people are looking for when they approach a financial adviser.

DC: Most people seek out an advisor because they think they are going to get some stock picking wizard. That is simply not the case. 

What you're going to get is a decisional guide who's going to protect you from your worst impulses. And while that may not sound as sexy as putting you in the next high flying stock, it is dramatically more valuable empirically. 

RP: So, how do you decide if a particular adviser is right for you? The crucial thing, says Daniel Crosby, is that you feel a strong sense of rapport.

DC: Do you like them? Because the things that they are going to ask you are very difficult. We are wired to spend. 

We are wired to take bad risks. We are wired for immediacy. And an advisor is going to ask you to be prudent, to be long term, to save, to do all of these things that are psychically very, very painful. 

And the only way that you're going to get the maximum benefit out of that advisory relationship is, if you like, the person that is sitting across from you. 

RP: In summary, our brains just aren't wired to make good financial decisions. That’s why having an adviser is so valuable. 

But remember, you’re not looking for an investment guru, but a behavioural coach, and you have to get on well with them.