MU financial expert explains how to avoid flawed thinking that leads investors to diminishing returns
March 7th, 2017
The views and opinions expressed in this “for expert comment” release are based on research and/or opinions of the researcher(s) and/or faculty member(s) and do not reflect the University’s official stance.
COLUMBIA, Mo. – Does it ever feel like your decision-making ability goes haywire when it comes to money? Research shows you’re not alone. Scientists working in the relatively new area known as “behavioral finance” have identified scores of mental biases that interfere with making choices involving money. In his new book, “The Foolish Corner—Avoiding Mind Traps in Personal Financial Decisions,” University of Missouri finance professor John Howe offers practical tips on avoiding such mistakes.
The book’s title is taken from an Aristotle quote in which the Greek philosopher said a “foolish corner” is in the mind of even the wisest person.
“As psychologists, economists and others who research human decision-making have found time and again, we humans are exceedingly good at shooting ourselves in the foot when it comes to money,” said Howe, chair of the Finance Department in the Trulaske College of Business. “Unseen psychological forces can impact everyday financial decisions, from buying a new washing machine to designing a retirement strategy. Unfortunately, most of us become aware of these forces only after the damage is done, if we do at all.”
Howe offers an introduction to these biases and a primer on how to overcome subliminal influences—and sometimes even use them to one’s advantage. Common behavioral pitfalls covered include:
- Loss aversion, or the natural tendency to feel losses more acutely than we feel gains.
- Overconfidence, which can lead to inaccuracies, distortions and costly mistakes.
- Herd behavior, which leads to questionable investments and decision-making based on what the “crowd”—even a small one—is doing.
- Affect bias, or unconscious perceptions about products or investments based on emotional responses.
“Biases can lead to poor decisions,” Howe said. “Without conscious effort on your part to counter these tendencies, they can control you like an autopilot system. However, being aware of biases and acting to offset their influences will lead you to improved, more rational decisions.”
“The Foolish Corner,” published by the Stuart Charles Group, was released in February. Howe has taught finance for more than two decades and serves on the boards of a variety of non-profit and for-profit organizations. His writings on banking, corporate finance and behavioral finance have been published extensively in major finance and accounting journals. Howe wrote the book with Robb Corrigan, a London-based consultant focusing on the asset management industry.