saber-toothed tigers presented a
more pressing threat than plummet-
ing stocks. Today, however, loss aver-
sion can be less helpful. “The same
instincts that prompt you to flee a
burning building make you want to
sell when the market’s low and buy
when the market’s high,” says
Elle Kaplan, founder of Lexion
Capital Management, a New York
City wealth-management firm. “But
that’s the opposite of what you need
to do to build and preserve wealth.”
To counter the effects of loss aver-
sion, avoid checking the balance on
your investment accounts more than
a few times a year, which should help
you avoid the temptation to move
your money in and out as the market
gyrates. And if you can’t trust yourself
to keep your instincts in check, con-
sider working with a financial adviser.
Think you can beat these trick questions?
Most of us are easily fooled, researchers say.
major impediment to saving. “We all
have self-control issues,” says econ-
omist Richard Thaler, who directs
the Center for Decision Research
at the University of Chicago. “Our
thought process often goes some-
thing like, ‘I’d like to save more, but
I’d like that big new TV even more.’
Then we realize that football season
is starting next week, and the idea of
saving goes right out the window.”
You may think you’re more rational
than that—and maybe you are. Let’s
find out. The following three questions
are typical of the ones used by behav-
ioral economists to demonstrate how
and why we make financial decisions
that go against our own interests.
Question #1
A salesperson is touting new
windows to a homeowner. Which
pitch is more likely to get a sale?
“Replacing the windows will
save you money.”
“You’re losing money by not
replacing the windows.”
The two pitches mean the same
thing, but the second is more effective.
Why? People fear immediate losses
more than they desire future gains.
Behavioral economists call this “loss
aversion”; they’ve documented we feel
the pain of losing about twice as strongly as we feel the pleasure of winning.
The instinct to flee from losses
probably served us well back when
Question #2
How do you pronounce the capital
of Kentucky: “Loo-ee-ville” or “
Loo-iss-ville”? Now, how much money
would you bet that you know the
correct answer: $5, $50, or $500?
This question, from the behavioral-economics book Why Smart People
Make Big Money Mistakes (1999) by
Gary Belsky and Thomas Gilovich,
is really a trick: Kentucky’s capital
isn’t Louisville; it’s Frankfort. While
you were congratulating yourself for
knowing the s in Louisville is silent,
you probably didn’t stop to wonder
if that was all you needed to answer
the question—a display of the human
tendency toward overconfidence.
Excess confidence leads people to
think too highly of their own skills—
even in areas in which they aren’t
very skilled. Eric Dahm, an investment adviser at Human Investing in
Portland, Oregon, sees this in clients
who hold a lot of retirement savings
in their employer’s stock. “ When
