If you have some time over the holidays, I recommend this 39 minute FT podcast (The Psychology Behind What We Do With Our Money) and accompanying paper: The Psychology and Neuroscience of Financial Decision Making. Why is this worth your time? It provides an fascinating summary of the latest experiments being run to help us understand why we make the money decisions that we do.

Here were some of the interesting tidbits (numbers refer to footnotes cited in the paper):

• How to increase savings behavior? Show your students what they will look like when they are older.

At the behavioral level, imagining one’s future self through age-progressed facial renderings increased savings behavior in an experiment [23]

• Reading account statements and agreements can impact financial decision making, including bank account overdrafts:

The salience of certain attributes on financial statements and contracts 664 Trends in Cognitive Sciences, September 2016, Vol. 20, No. 9 has been shown to affect payday-loan borrowing [30], trading behavior [31,32], and bank account overdrafts [33].

• Research shows that overtrading of stocks is not an optimal strategy but many do it. Why? 

However, the data indicate that most individual investors who trade at all trade too much and lose money by doing so [42]. Such ‘overtrading’ may be driven by overconfidence, in the sense that investors mistakenly believe they have better information than they actually do. Another explanation for the high volume of trade is that investors derive entertainment from doing so. One interesting study shows that speeding tickets (a proxy for sensation seeking) and perceiving one’s intellect to be above actual intellect (a proxy for overconfidence) are associated with higher trading frequency [43].

• Why do investors continue to own actively managed funds which typically underperform index funds? 

There is no consensus on why active management is so popular. A plausible psychological principle is that households misunderstand the roles of luck and skill. They expect a fund to perform poorly after a short streak of high returns. When the fund then does well (perhaps luckily), they become mistakenly convinced that the fund’s managers are skilled [14].

_________

• Your students will likely avoid getting overdraft protection (and paying those fees) after they complete this Fine Print mini-activity.

• Here’s an NGPF mini-activity where students consult their future selves.
• Want to humble your students who think they can “time the market?” Try this simulation which will show them why overtrading is a bad idea.

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

More posts by Tim