Posted August 28, 2020 in Podcast
Money Talks: 3 Biases That Can Ruin Your Financial Plan with Dr. Dan Pallesen
We are just not wired to make good financial decisions.
Agree or disagree? Let’s look into this some more…
Our brains are powerful tools, and they do a fantastic job of protecting us. They’ve figured out all kinds of pathways and shortcuts to help us make the thousands of decisions we make every day as quickly as possible. And most of the time, that’s good news. Our brains keep us alive and healthy this way. But when it comes to making sound financial decisions, it’s a different story.
When we think about financial planning and investing, we’re not thinking about making quick, short-term choices. Investments are designed to grow over long periods of time, and financial planning is all about ensuring a secure financial future many years down the road. We need to be considering the long-term implications of where we’re putting our money to ensure our financial portfolios grow.
So our brains are wired to make short-term choices, but financial planning is necessarily a long-term endeavor — it’s probably a good idea to have a financial advisor with a background in psychology! I’m reminded of something I learned when my wife and I followed the Dave Ramsey plan: He says that personal finances are 80% about behavior and 20% about head knowledge. Our choices, instincts, and behaviors have a huge influence on our financial lives! Thankfully, my guest today is the perfect person to help us navigate how our brains are wired to influence our financial decisions.
Dr. Dan Pallesen is an expert financial advisor with a doctorate in psychology. I interviewed him recently, and I learned so much from our conversation that I’ve decided to divide it up into a series of episodes I’m calling “Money Talks.” Today’s episode is part one, and we’re talking about the three biases we have hardwired into our brains that we need to consciously consider when we make financial decisions. Let’s get started!
Who Is Dr. Dan Pallesen?
Dr. Dan Pallesen is a licensed professional financial advisor, but he didn’t start out in that field. After earning his doctorate in psychology, he worked as a clinical psychologist for over 10 years. During that time, he worked in some interesting places — He was a prison psychologist in federal prisons and a behavioral health consultant in US military medical clinics.
During his time working for the US military, Dr. Dan often worked with patients who dealt with health issues not specifically related to their mental health — hypertension, high cholesterol, and smoking, just to name a few examples. Dr. Dan realized that behavioral health solutions could remedy a whole range of problems, and he was only one step away from using his psychological approach to financial advising.
One day, Dr. Dan was approached by a good friend who needed a financial advisor to join his practice. He specifically sought Dr. Dan because of his psychology background, knowing that he could better advise clients from a behavioral standpoint. Dr. Dan agreed to join the practice, passed his ethics and law exam, and the rest is history!
I love the way Dr. Dan has combined his education with practical application. His unique approach to financial advising that accounts for our human behavior is something that I think we can all benefit from. He truly believes that when you understand what drives your money behaviors, you harness your power and live life with purpose. Sound like something you’d like to learn about? Then make sure to grab some paper and a pen because you’re going to want to take notes!
Confirmation Bias: Our Brains Tell Us What We Want to Hear
As I mentioned earlier — when it comes to financial planning, we have to think long-term. If you’re going to invest in stocks, bonds, or anything else, you have to be prepared to wait a few years or even decades before you’ll see a payoff on that investment. But remember — our brains aren’t really wired to do that. We tend to make quick decisions and take quick actions to try to get to the result as fast as possible. Dr. Dan says that’s mostly a good thing, but we have to be able to shift out of that pattern when it comes to our finances.
“We’re constantly seeking pleasure and avoiding pain. That’s sort of how we navigate life. But to be a good investor, you have to take on a little bit of pain and endure it. And you have to put off some pleasure until later on.” – Dr. Dan Pallesen
But here’s the thing: Often, we find ourselves surrounded by signals that tell us to buy, buy, buy or sell, sell, sell as fast as possible. And when that happens, we fall back on something called confirmation bias.
“All of the information that comes in throughout the day, we sort of filter, right? And things that don’t align with how we already see the world, we just subconsciously let that go. We don’t even remember it. And if there [are] things that we hear that support the way that we already think about the world, we hang onto that.” – Dr. Dan Pallesen
So our brains are wired to make quick decisions, and we’re constantly receiving information that tells us to take action as fast as possible — That’s not a recipe for sound financial decision-making. Our brains will naturally accept the signals that we should buy or sell as quickly as possible because they confirm what we already believe. That’s why it’s called the confirmation bias. But to make sound financial choices for our futures, we have to intentionally filter out that information and be ready to wait for our investment returns.
Collective Knowledge vs. Individual Knowledge
Dr. Dan used a great example that I think illustrates the second principle I want to talk about very well:
Have you ever seen one of those little contests where there will be a jar of M&Ms, and everyone has to guess how many M&Ms are in the jar? You might see a long list of people’s guesses, and they’re going to vary slightly. But if you take the average of all the guesses, you’re going to come up with a number that is closer to the correct answer than most of the guesses.
“When you take this big group, we all kind of have an idea of what’s right, but none of our individual guesses tend to be right. But that’s the opposite when it comes to investing.” – Dr. Dan Pallesen
When you’re thinking about financial planning, the collective idea of what’s “correct” is typically not what’s right for you! Think about it in terms of investing in the stock market. When the market and the prices are high, and a lot of people are putting their money into the market, that’s actually the best time to sell and make a high profit. And when the market is low, and prices are down, that’s when you want to buy — you can purchase shares for low prices, wait until they rise, and sell at a profit.
See what I mean? If you go along with the majority opinion, you’re not making the best decisions.
“If you’re taking that herd mentality and following the mass majority, you’re probably not doing very well for your financial plan when that tends to do well for you in other areas of life.” – Dr. Dan Pallesen
That’s why it’s so important to make sure you’re getting sound financial advice. If you take action based on trusted financial advisors and your individual knowledge of what’s best for you and your investments, you’ll make wiser choices and make greater profits!
Action for the Sake of Action
The final bias Dr. Dan talked about in our conversation is called “action bias.” This goes back to what I talked about earlier — our brains are wired to make decisions and take action quickly, but that’s not always best for our financial planning. Dr. Dan explains it like this:
“Action tends to make things worse when it comes to investing. We have this thing … called ‘action bias’ — when we’re just not even sure of our footing on the ground, we have this desire to do something for the sake of doing something to feel like we’re getting some control back. … [But] action just for the sake of action, when it comes to investing — I won’t get into the research, but it just shows over and over again that overtrading actually hurts the performance of your portfolio. But if you’re able to be patient and not do anything, that’s what really helps to have good longterm success.” – Dr. Dan Pallesen
When we’re not sure what to do, we tend to jump into hasty action instead of hanging back, gathering information, and making wise financial decisions. But it’s essential to take a step back and look at the big picture before making any major choices.
When it comes to financial planning, we have a lot more clarity the further out we look. For example, you might not know if your investments are going to increase or decrease tomorrow, but you probably have a general idea of where they’ll be one or five or ten years from now. Don’t be afraid to take your time and look at the longterm implications of a certain investment opportunity. It’s not a bad thing to take it slow! In fact, it’s important not to rush into financial decisions — they’ll affect you a long time into the future, and you want to make the best choices you can for you and your family.
Reach Beyond with Dr. Dan Pallesen
So what can we do about these biases? How can we overcome the obstacles in our brains and make the best financial planning decisions we can? Dr. Dan says it’s about getting kind, generous guidance:
“It’s pointing things out in a loving way. … I’m not going to identify all these biases and say, ‘Hey, I caught you. You’re dumb. You’re bad. Your brain is wrong.’ No, it’s saying, ‘Hey, this is how you think. This is how you’re wired. That’s okay. But to be a good investor, we have to break through this and get you to agree to a good plan that can take you through times of volatility where you want to jump ship.’” – Dr. Dan Pallesen
I want to encourage you all to find someone who can help hold you accountable as you make your financial plans. This could be a friend or family member or, better yet, a trustworthy financial advisor like Dr. Dan. You want someone who can kindly point out when your biases are trying to get the better of you and help steer you in a wiser direction. In fact, if you want to reach out to Dr. Dan himself, you can find him on any of the links here. He’s an excellent source of information, and I’m sure he’d be happy to answer your questions.
Thank you so much for joining me for part one of our “Money Talks” series, friends! I hope you found this information helpful and inspiring. If you did, I’d love it if you’d share a screenshot of the episode on Instagram. Tag Dr. Dan, @drdanpallesen, and me, @kyle_depiesse, with your biggest takeaways from the episode. And if you have an extra minute, I would appreciate it if you would leave me a five-star review over on Apple Podcasts. Every review helps this podcast find new listeners!
Cheers to your success. I’m rooting for you.
Until next time —