Why People Make Bad Decisions About Money
Daniel Kahneman on how the psychological tendencies of narrow framing and hazy generalizing limit the effectiveness of people’s decision making about money (and other things):
More foolishly, when we invest in the stock market, we see each stock we buy as a mental account that we should sell as soon as it’s a winner. This means that investors end up selling their winners and hanging on to their losers, which, in the long run, makes them poorer than if they’d just kept the winners.
There are two major reasons for these recurring patterns of behavior. First, people often see their choices narrowly, attacking a problem as if it is singular and unique — as if this is the only time they will ever encounter this specific situation. Usually, “it’s a better idea to look at problems as they will recur throughout your life, and then you look at the policy that you’re to adopt for a class of problems,” says Kahneman. So instead of saving and borrowing at the same time, treat your whole portfolio of assets holistically.