On Guard Against Irrationality

Do you behave rationally in your financial decisions? A professor at Duke University, Dan Ariely, describes most people's behavior as "Predictably Irrational." He's written a book on the topic and is the subject of an article in a recent issue of Investment Advisor, where he talked about why people make common mistakes with their financial plans. See if any of his findings apply to you:

* Are you asking the right questions? Ariely says that one of the causes of the housing bubble is that people started asking themselves "How much house can I afford?" rather than "How much should I spend on a house?" When you can't figure out the answer to a question, maybe it's' time to step back and ask yourself if you're even looking at the problem in the right way.

* Are you in the proper emotional state? Taking big losses or big gains in the stock market can create an emotional state wherein an investor is willing to take even bigger risks. People make their best, most rational decisions in a cool emotional state. If you've had a substantial change in your financial state, think about whether it's the right time to make the most rational decision.

* Are you using money when you should be giving of yourself instead? If you run a business, money is an expensive way to create worker loyalty. It's easier on everyone to create a social model wherein the business cares about its workers in areas like sick leave and team-building. A rival can always offer your employees more money, but no one can steal them by promising more of a family environment.

Ariely's next book will be called The Upside of Irrationality. That will be worth keeping an eye on as well.