I recently had the opportunity to speak at a Mensa gathering on the topic of why smart people don't always make the best financial decisions. The event was Dr. Seuss themed, and this quote from his famous book "Oh, the Places You'll Go!" sums up a lot of the reasons.
I've included a link to my presentation, but the highlights regarding WHY are summarized here:
In general, success is a product of several things – talent, skills, and decisions-making, and most scholars on the topic of behavioral finance will tell you that decision-making has twice the impact of the other two.
While you can’t improve your IQ to increase your talent or skills, you can develop stronger decision-making capabilities when you understand in behavioral finance, we are hardwired to be emotional first, and logical second. Financial decisions are heavily influenced by emotions and psychological patterns: biases, heuristics, and framing effects.
Here are my 3 reasons why smart people don’t always make the best financial decisions:
1. Intelligence increases the ability to fool yourself with elaborate stories about why something happened.
Average people often learn faster than the super intelligent, because the super intelligent try to cram the real world into the theories they’ve been taught, while average folks are sometimes better at accepting the real world at face value. Here’s the thing: we judge others based solely on their actions, but when judging ourselves we have an internal dialogue that justifies our mistakes and bad decisions. Two things come from this:
- We think of ourselves as less flawed than other people, because we rarely hear the internal justifications other people have for their mistakes, but we are keenly aware of our own.
- And two, the smarter and more creative we are, the more elaborate stories we can tell ourselves to justify our poor decisions.. When you’re blessed with intelligence, you’re also cursed with the ability to use it to concoct intricate, and often false, stories about why things happened.
2. Intelligence pushes you toward the idea that complex problems require complex solutions.
Try spending a few hundred thousand dollars on a college education, professional designations, licensing exams and continuing education, and then devoting your career to telling people that you can’t predict the economy. But some of the most complex problems require the simplest solutions, since simple solutions are the ones that navigate around – rather than trying to steer through – parts of a problem that are fundamentally unknowable. The brilliance of a dollar-cost-averaging strategy is not that it knows what the market will do next. It’s that it doesn’t need to know for it to work.
Even when a problem requires a complex solution, the ability to communicate it in simple terms is indispensable to getting people to take you seriously. Albert Einstein, Warren Buffett, and Steve Jobs are all brilliant, but a lot of people are brilliant. I was surrounded by brilliance at the Mensa gathering. What made those three famous is their ability to distill complexity into something elegant and simple enough for the average people to understand, or even use.
3. Intelligent people prefer to rely on patterns and formulas over emotion.
This one really resonates with me and also is best represented by the Callen charts in my presentation. I’m that kid that separated candy, marbles, lego tiles, rocks etc. by colors, size, shapes, any type of association or patterns I could find. How many of you love those types of puzzles or problem-solving challenges?
Take a look at the Mensa uRGe Slide Deck - paying close attention to the charts and graphs of market data all the way back to 1926.
If you’ve read this Dr. Seuss book, you are instantly reminded that this color-infused, wildly illustrated book is not a children’s book at all. It was meant for everyone. There are a lot of answers on the pages of this book, as well as his other classics, and they aren’t complicated at all, even though we would like to think that all the answers have to be complicated. Sometimes stepping back and realizing the power of simplicity, particularly when it comes to investing, is a far better course.