Amy Jansen, Head of Behavioural Solutions, explores the cognitive biases that are omnipotent in decision making when it comes to cash management and how just being aware of these is the first step to more efficient money management.
Can you be unbiased when making investment decisions?
A bias is a pattern that we repeatedly follow. If it’s inappropriate, it can lead to mistakes in the same direction. Hindsight bias is a tendency for people to perceive past events as having been more predictable than they were. Another is sunk cost bias, which is particularly dangerous in a corporate environment. When you’ve made a decision and invested money, resources, time and energy, when you make another decision about the same issue, even if it starts to look like you didn't make the right decision initially, because of how much you’ve already invested in it, you are more likely to continue in the same direction. Sunk cost bias is rooted in a much deeper and more prevalent bias known as loss aversion. Loss aversion is where people invest twice as much effort to prevent a loss than to get an equivalent gain.
Understanding your brain in a new way
Imagine a company inside your head. There are three layers. At the top is the CEO or your prefrontal cortex. This is where executive control sits and refers to higher cognitive functioning. At the bottom are the robots, the largely unconscious parts of your brain that you really don't have access to. One of these is your energy management system. Your robots or autonomic nervous system determine whether you're going into fight or flight or rest and digest. These decisions can be important because they say how much energy the rest of your brain has available relative to the rest of your body. Most the time you don't have that much control over it and energy is critical when it comes to understanding your brain. The CEO is an energy hog. Your brain is 3% of your mass and 20% of the energy you consume every day. The middle layer of your brain are the minions, and they are the stars of the show as they have to protect the CEO at all costs. As a result, they are responsible for 80% of the decisions you make every day.
Your brain minions
You have very excitable minions on one side who get excited and want to get involved. You also have loss averse minions who always look on the downside and try to protect you. The problem is both can make mistakes, so you need to be super careful when you're in your minion layer. To make sure that your CEO is not chewing up too much energy and expending itself, your minions will look for any patterns or habits, including how you make decisions. Your minions are responsible for the things you master and the mistakes you make. While your minions are here to help, they can also be where all the biases come from. Repeated patterns go from being appropriate where they are useful shortcut to being inappropriate and leading you to making repeated mistakes, which is what we call a bias.
How to manage your CEO and minions when thinking cash management and investment?
Your impulse may be for everything to go to your CEO. But, if you’re doing something repeatedly, you want it to be in your minion layer and get the most out of it. If you are making repeated high stakes decisions, you need to look at what your minions are doing. How are you looking at the information when you get it? What are the shortcuts? What are the checklists you are using mentally in your brain and are they the ones that you would like to be using? This is one of the best uses of your CEO. Use it when you're making New Year's resolutions but not when you’re trying to have self-control to go to gym. One ritual that can be useful and get great returns is cash sweeping. It can be built into the end of your day, either yours or someone in your team. A good ritual must be the last thing you do and if you do this, you create a ritual for your minion. If you’re working at home, having a ritual to close out the day will help you to switch from work mode to home mode that much more effectively.
Setting your CEO up for success
If something is new, unusual or an area where you need to learn, you need to set up your CEO for success. That means do it early in the day or early in the week. If you want to make good, high stakes decisions that are novel, you need to put it at the beginning of your agenda. The same goes for learning.
Learn what you need to learn and then create the rituals for your minions to keep you going in the direction you want to go.