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How to make better decisions, according to a behavioral economist

Ethan Wolff-Mann
Senior Writer
(Getty Creative)

James Holzhauer’s run on “Jeopardy” was impressive for many reasons, not least because the professional gambler knows a ridiculous amount of trivia.

But above all, the champion, who walked away with over $2.4 million in 33 appearances, won because of how he played — not just with panache, but by sticking to a well-thought-out plan of betting without fear.

There’s a lot to learn from his performance, like the fact that playing things too safe is actually very risky . But there’s an even more obvious direct parallel: having an understanding of behavioral economics and how we can use it to improve our own decision-making — to create a better strategy and to stick with it.

First off, it’s not about being a robot-like, emotionless actor.

“It’s a bit of a myth that emotion is a counter to reason,” says Dr. Deborah Small, a professor at the Wharton School who studies behavioral economics. According to Small, it’s an incredibly important part of the equation and could cause serious problems if it’s not given its due.

Emotion, it’s almost too obvious to say, is very useful for helping you evaluate how important outcomes are. If you have a strong aversion to a certain outcome, you can make sure that is taken into account when making a decision.

The obvious downside to emotions, however, is that they can lead people astray.

People — like Warren Buffett , for example — frequently talk about how much money you’d have if you invest in an S&P 500 index fund and didn’t touch it for 30 to 40 years. And if you have an automatic contribution every paycheck, you’ll be even richer.

At the same time, temptations to ditch the conventional wisdom and instead try to pick the best stock and buy it at the best moment are siren-like in practice.

The kind of emotion that often leads us astray is when we plan to pursue a certain behavior or strategy and all of a sudden, in the heat of the moment, emotion prevents us from seeing the big picture and causes us to change course.

“What [Jeopardy’s Holzhauer] did, which was really effective, is that he stuck to his rules in the heat of the moment, when fear might have led him to change his preferences,” says Small.

Small says that the best solution is to do everything possible to take the longer view – in the case of investing, that means the market goes up over the long term. That’s why losing the password to your 401(k) account for a while can sometimes be for the best.

‘Choice bracketing’ for the long term

The concept of “choice bracketing” is one effective way to promote this sort of long term-ism. Each decision — no matter how inconsequential or scary it seems — is a part of a larger picture that matters, says Small. Broadly grouping choices together helps shed light on the effects over time of a certain strategy. One cigarette doesn’t matter, but 20,000 might; saving 10% of a paycheck might not be much, but years saving from every paycheck might; selling now might protect your nest egg for the near future, but it might hurt you in the long run.

“Narrow bracketing, on the other hand,” reads the 1999 study in the Journal of Risk and Uncertainty that coined it, “is like fighting a war one battle at a time with no overall guiding strategy, and it can have similar consequences.”

Behavioral economists say this type of thinking can bring clarity to all kinds of decision-making — including financial decisions like retirement saving and sticking to a budget, and even decisions about your health — pretty much anything that involves self-control.

But bracketing only works well when there is a fundamental plan to fall back on. You cannot be comforted by sticking to a strategy that you don’t have or that’s not adequate.

“The more concrete detail [in the plan], the more likely you are to stick with it,” says Small. In any given moment, you might be faced with a decision precipitated by some unexpected changes. “If you haven’t thought about it before, aspects in the moment are going to matter more,” she says.

Tools to overcome our irrational tendencies

Another central tenet of behavioral finance is that we often do things that may be nice in the short run but not in the long run. A mini-industry of self-control apps and tools has popped up to help humans overcome their own worst enemies — themselves.

Apps like Acorns automatically save money for you. Employers push automatic 401(k) contributions. Bank apps let you put spending limits on cards and withdrawals. At the very minimum, these “commitment devices” make sure people take an extra step and time to reflect before overcoming or bypassing them.

“When people know they are going to give into self-control issues, they can limit their own choices to help themselves,” says Small. “A lot of those retirement programs are designed in many ways to make it extra costly to take money out, but it’s interesting when people do it to themselves.”

One odd trick Small heard was people who put their credit cards in a bowl of water and stuck it in the freezer. If they wanted to spend, they’d have to wait out a thawing period. There are apps that act as restraints to at least make sure some decisions get a little time for reflection.

Our tendency to prioritize the present over the future is another bias to get over. New technology has emerged that uses virtual reality to help people get over a nearsighted bias of the present. If VR can help see them as an older person, approaching or in retirement, perhaps they will spare a thought for their future self.

Learn some cognitive biases

Perhaps the most useful thing a person can do is take the time to understand themselves and how they think in decision-making circumstances.

“Self-awareness and awareness of cognitive biases in general leads to better decision-making,” says Small. “Part of it is because we can act on those things. Why would I be motivated to set up a ‘commitment device’?”

One simple way to help yourself combat potential pitfalls, can be as simple as just knowing what they are .

A few useful ones to know about: Cognitive depletion and decision fatigue means we make poor decisions when we’re tired. Loss aversion means we feel very bad about losses, but only moderately positive about wins. Primacy bias often makes us focus on what we hear first. Status quo bias means we may simply prefer the familiar over the unfamiliar. The availability heuristic holds that we often judge probabilities based on the data that is immediately easy to find. The planning fallacy says people generally are bad about accounting for the unexpected, thinking that the plan will unfold as predicted.

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Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann .

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