The book highlights common mistakes that people make while thinking about money and making money decisions. It also gives ideas on how to circumvent these potentially loss making behaviour.
For example, some people treat 'found' money (gift from grandparents, lottery win) different from other income. The sudden windfall is not treated same as the salary earned. This leads to unnecessary spending. The solution to avoid this is to imagine all income is earned income or stash the money away for some time.
People take on more risks to avoid loss and less risk to earn profits. The more options people get, the less action they take. For example, you have already invested in certain assets. You realise you have the opportunity to change the investment portfolio to earn more. The other option is to do nothing. Most people choose the second option. It is important to understand that not taking a decision is also a decision and this might be detrimental to your investment portfolio.
Other mistakes people make are
- They consider themselves smart and believe they have made the best financial decisions
- Numbers are not considered accurately in their calculations
- Herd Mentality
- Sunk cost fallacy
2) The Little Book of Behavioral Investing - It is written by James Montier. It shows us the common behavioural traits which lead us to getting less than optimal returns and how to overcome these traits.
The book talks about the following behavioural challenges and tips to overcome them -
- Impulse buying, ADHD buying
- Stop investing when one makes a loss
- Making too much of experts comments and analysis and the overload of information available in all forms of media
- Buy and sell on the basis of hearsay, other people's investment actions and rigid assumptions without validity.
- Investor Bias
Key Takeaways - As an investor, you should research and plan your investments. You should analyse information before making buy and sell decisions. It is important to understand that you might make some losses but with a sound investment strategy that is regularly reviewed, you would achieve your financial goals.
3) Thinking Fast and Slow - It is written by Nobel Prize winner Daniel Kahneman and Amos Tversky. It is a great insight into how the human mind works. The book says that the human mind has two systems –
System 1 – It is intuitive, impulsive and automatic
System 2 – It is rational, conscious and considerate.
Both systems have conflicts which can lead us to make errors in rational thinking. The book does not delve into finances but a lot into behaviour and how our mind works. If we are able to exercise control over our mind and get System 2 into action, we can make rational long-term financial decisions.
System 1 makes you overconfident leading to confirmation bias. It also responds very strongly to losses than gains leading to loss aversion.
Key Takeaways - There are many examples and research details in the book that show how System 1 takes charge and does not always make the most efficient decision. There is a study that shows active traders made less money compared to investors. It is imperative that you allow System 2 to take charge in terms of finances so that you make rational decisions after considering all aspects.
4) Predictably Irrational - The Hidden Forces that Shape Our Decisions - It is written by Dan Ariely in which he gives an account of how humans behave irrationally which affects their decision making capability. Some of the irrational behavioural traits that he mentions are -
Comparison – We compare jobs, cars, houses, lifestyles with others and try to keep up. This results in overspending and never being happy with what we have.
Cost of Zero – We are excited when something is free but do not look at the other aspects of it.
Self-Control – We have little self-control. We do not save enough on our own. But on the other hand, if something becomes mandatory, we are able to save that money. Many of us cannot keep a check on our credit card spending. Such traits can lead to our finances going out of control. We all know that we have to save for retirement. But many of us do not want to put in effort to calculate the amount and work towards it and we procrastinate the task.
Key Takeaways -The book uses everyday situations to portray that humans do not think rationally all the time. This can lead to bad decision-making in finances.
It is a good book to read to understand where we are going wrong and take steps to take the rational approach.