10 Unbelievable Lies That People Believe

Why People Do Dumb Things With Money

15 Biases That Make You Do Dumb Things With Your Money

By Morgan Housel 

You are your own worst enemy.

Those are the six most important words in investing. Shady financial advisors and incompetent CEOs don't harm your returns a fraction of the amount your own behavior does.

Here are 15 cognitive biases that cause people to do dumb things with their money.

1. Normalcy bias Assuming that because something has never happened before, it won't (or can't) happen in the future. Everything that has ever happened in history was "unprecedented" at one time. The Great Depression. The crash of 1987. Enron. Wall Street bailouts. All of these events had never happened... until they did. When Warren Buffett announced he was looking for candidates to replace him at Berkshire Hathaway, he said he needed "someone genetically programmed to recognize and avoid serious risks, including those never before encountered." Someone who understands normalcy bias, in other words.

2. Dunning-Kruger effect Being so bad at a task that you lack the capacity to realize how bad you are. Markus Glaser and Martin Weber of the University of Mannheim showed that investors who earn the lowest returns are the worst at judging their own returns. They had literally no idea how bad they were. "The correlation between self-ratings and actual performance is not distinguishable from zero" they wrote.

3. Attentional biasFalsely thinking two events are correlated when they are random, but you just happen to be paying more attention to them. After stocks plunged 4% in November 1991, Investor's Business Daily blamed a failed biotech bill in the House of Representatives, while The Financial Times blamed geopolitical tension in Russia. The "cause" of the crash was whatever the editor happened to be paying attention to that day.

4. Bandwagon effect Believing something is true only because other people think it is. Whether politicians or stocks, people like being associated with things that are winning, so winners build momentum not because they deserve it, but because they're winning. This is the foundation of all asset bubbles.

5. Impact bias Overestimating how big of an impact an event will have on your emotions. Most people are utterly terrible at predicting how happy they'll be after receiving a raise, or getting a new job, particularly as time goes on. We get used to more (or less) money quickly, but it's extremely difficult to realize that before it happens. Your financial goals might change after coming to terms with this.

6. Frequency illusion Once you notice an event, it seems to keep happening over and over. But it's often not; you're just paying more attention to something you were once oblivious to. The 2008-09 market crash was such a memorable event that I think investors and the media became infatuated with today's "volatile market." But the last three years have actually had below-average market volatility. We're just more attuned to normal market swings than usual.

7. Clustering illusionThinking you've found a pattern by taking a small sample out of a much larger one. For example, we know stocks' daily movements over time are random and unpredictable, but you could take a four-day period where a stock went up, up, down, down, and think you've found a trend. Day traders are attracted to clustering like bugs to bright lights.

8. Status quo biasIrrationally wanting things to stay the same. People do this in part because they want to avoid costs even when they're offset by a larger gain -- a process psychologists call "loss aversion." You stick with the same bank even though it charges higher fees than another. You hold onto a stock you inherited even when you know little about it. You don't make changes to your portfolio even when it's not designed for your goals. You just want things to stay the same -- a dangerous mind-set in a world that's always changing.

9. Belief bias Accepting or rejecting an argument based on how well it fits your pre-defined beliefs, rather than the objective facts of the situation. Pointing out that inflation has been low for the last five years is still met with suspicion by those who believe the Federal Reserve's actions must be causing hyperinflation.

10. Curse of knowledgeWhen educated people can't comprehend that lesser-educated people think and act differently from them. Financial advisors and journalists fall for this all the time, spouting off lingo and catch phrases without realizing their customers have no idea what they're talking about (and are too afraid to ask for clarification). This also explains why there's a wide gap between academic theory and real-world reality. Economists who understand finance wrongly assume lay people will act in their best interests. Wall Street banks rightly assume they won't.

11. Gambler's fallacy The belief that future events will be shaped by past events, even when the two have no correlation. A gambler will assume a coin is due to come up heads after flipping a string of tails, but the outcome of the next flip is completely independent of the last one -- the odds are still 50/50 regardless of prior flips. Investors fall for a version of gambler's fallacy when assuming things like economic data, quarterly earnings, and politics will dictate the direction of the market, when in reality the two often move independent of each other. Randomness is hard to accept.

12. Extreme discounting Preferring a small but immediate payoff over of a larger payoff down the road. Some discounting is rational, but investors consistently take it to the extreme. People who have decades ahead of them to invest trade in and out of the market to avoid small, short-term losses, almost always at the expense of long-term returns.

13. Ludic fallacy Coined by Nassim Taleb in The Black Swan, the naive belief that the real world can be predicted with mathematical models and forecasts. It leads people astray because models are purposely simplified while the real world is incomprehensibly complex. As author Dan Gardner says, "No one can foresee the consequences of trivia and accident, and for that reason alone, the future will forever be filled with surprises." Ninety percent of stock analysts and economists would disappear if we'd all just accept the ludic fallacy.

14. Restraint biasOverestimating your ability to control impulses. Studies show smokers in the process of quitting overestimate their ability to be say no to a cigarette when tempted. Investors do the same when thinking about the temptation to do something stupid during market bubbles and busts. Most investors I know consider themselves contrarians who want to buy when there's blood in the streets. But when the blood arrives, they panic just like everyone else.

15. Bias biasThe most important and powerful bias of them all, "bias bias" is the belief that you are less biased than you really are. If you read this article without realizing I'm talking about you, you're suffering from bias bias.

Everyone is prone to cognitive errors. Some more than others, but no one is exempt. Coming to terms with the idea that you are your own worst enemy is the single most important thing you can do to become a better investor.

Daniel Kahneman, who won the Nobel Prize for his work studying cognitive psychology, once said, "I never felt I was studying the stupidity of mankind in the third person. I always felt I was studying my own mistakes." When you realize you are as biased as everyone else, you've won the game.

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10 Statistics About Youth That Point To A Futile Future

Actually there are 3 times more than 10 statistics.

#1 The labor force participation rate for men in the 18 to 24 year old age bracket is at an all-time low.

#2 The ratio of what men in the 18 to 29 year old age bracket are earning compared to the general population is at an all-time low.

#3 Only about a third of all adults in their early 20s are working a full-time job.

#4 For the entire 18 to 29 year old age bracket, the full-time employment rate continues to fall.  In June 2012, 47 percent of that entire age group had a full-time job.  One year later, in June 2013, only 43.6 percent of that entire age group had a full-time job.

#5 Back in the year 2000, 80 percent of men in their late 20s had a full-time job.  Today, only 65 percent do.

#6 In 2007, the unemployment rate for the 20 to 29 year old age bracket was about 6.5 percent.  Today, the unemployment rate for that same age group is about 13 percent.

#7 American families that have a head of household that is under the age of 30 have a poverty rate of 37 percent.

#8 During 2012, young adults under the age of 30 accounted for 23 percent of the workforce, but they accounted for a whopping 36 percent of the unemployed.

#9 During 2011, 53 percent of all Americans with a bachelor’s degree under the age of 25 were either unemployed or underemployed.

#10 At this point about half of all recent college graduates are working jobs that do not even require a college degree.

#11 The number of Americans in the 16 to 29 year old age bracket with a job declined by 18 percent between 2000 and 2010.

#12 According to one survey, 82 percent of all Americans believe that it is harder for young adults to find jobs today than it was for their parents to find jobs.

#13 Incomes for U.S. households led by someone between the ages of 25 and 34 have fallen by about 12 percent after you adjust for inflation since the year 2000.

#14 In 1984, the median net worth of households led by someone 65 or older was 10 times larger than the median net worth of households led by someone 35 or younger.  Today, the median net worth of households led by someone 65 or older is 47 times larger than the median net worth of households led by someone 35 or younger.

#15 In 2011, SAT scores for young men were the worst that they had been in 40 years.

#16 Incredibly, approximately two-thirds of all college students graduate with student loans.

#17 According to the Federal Reserve, the total amount of student loan debt has risen by 275 percent since 2003.

#18 In America today, 40 percent of all households that are led by someone under the age of 35 are paying off student loan debt.  Back in 1989, that figure was below 20 percent.

#19 The total amount of student loan debt in the United States now exceeds the total amount of credit card debt in the United States.

#20 According to the U.S. Department of Education, 11 percent of all student loans are at least 90 days delinquent.

#21 The student loan default rate in the United States has nearly doubled since 2005.

#22 One survey found that 70% of all college graduates wish that they had spent more time preparing for the "real world" while they were still in college.

#23 In the United States today, there are more than 100,000 janitors that have college degrees.

#24 In the United States today, 317,000 waiters and waitresses have college degrees.

#25 Today, an all-time low 44.2 percent of all Americans between the ages of 25 and 34 are married.

#26 According to the Pew Research Center, 57 percent of all Americans in the 18 to 24 year old age bracket lived with their parents during 2012.

#27 One poll discovered that 29 percent of all Americans in the 25 to 34 year old age bracket are still living with their parents.

#28 Young men are nearly twice as likely to live with their parents as young women the same age are.

#29 Overall, approximately 25 million American adults are living with their parents according to Time Magazine.

#30 Young Americans are becoming increasingly frustrated that previous generations have saddled them with a nearly 17 trillion dollar national debt that they are expected to make payments on for the rest of their lives.

Something is looming on the horizon and it is not a beach party.