The influence of psychology on economics showed a side of human behavior that was often not rational. Understanding how and when one’s biases can creep into financial decision-making may help you “self-correct” back to a more rational and effective plan.
Dr. Richard Thaler, a University of Chicago economist, won the 2017 Nobel Economics prize for his work in this area. He postulates that humans have two systems for processing information specifically as it pertains to economic decisions 1: The first type of decision maker is basing decisions upon reflective analysis (“conscious thought”), which Thaler gives the formal name of Econ (and the informal name of Mr. Spock). The second system is basing decisions upon automatic thought (“gut reaction”) and is called Human (or Homer Simpson). Several issues can arise with gut reactions, as they are based upon psychological biases and mental shortcuts that may lead to irrational decision making.
What follows are brief descriptions of common psychological biases people face during the financial decision-making process, and examples of how our Human and Econ selves may deal with them.