Gut instincts can be a reliable guide when falling in love, making friends or deciding whether or not to respect or trust someone. Yet when it comes to making investment decisions, it often pays to have second thoughts about first impressions.
Sound decisions involving money require careful thinking and layers of reasoning, says David E. Adler, a behavioral economist and author of "Snap Judgment: When to Trust Your Instincts, When to Avoid Them and How to Avoid Making Big Money Mistakes."
"My basic research shows our instincts are pretty useless when it comes to money," he said. "Our instincts evolved for whether we liked or were afraid of someone. Our instincts did not evolve for evaluating a stock or bond, which require more abstract skills."
As the nation struggles to claw back to financial health in the aftermath of the mortgage and credit crisis, Adler is convinced that it was largely the result of a collective snap judgment and an extreme example of what can go wrong when people follow their feelings instead of reason.
Homebuyers were going deeper into debt to finance bigger and bigger houses, trusting their gut and thinking real estate would only go up in value. Meanwhile, investment banks were victims of their own instinctive greed for higher profits, thinking less about the health of the system and how the system's overall health could ultimately make or break their own.
"Bernard Madoff played on people's instincts because he seems so trusting and he lulled people by ... promising a reasonable, but not outrageous return," Adler said. "Our instincts would say he sounds like a nice guy."
But outside of the stock market and financial matters in general, it's advisable to trust your instincts, he said. If the question is "Do you like your spouse?," you don't get a better answer by committing more thought to it.
You are better off trusting your first thought.
Educated at Oxford University and Columbia University, Adler holds a master's in economics from Columbia and writes for several national publications including Psychology Today magazine.
"Snap Judgment," published by FT Press, notes a laundry list of common flaws in everyday money and investment decisions, including why investors are prone to sell winning stocks yet hold on to losers because they don't want to sell at a loss.
(Tim Grant can be reached at tgrant(at)post-gazette.com.)
(Distributed by Scripps Howard News Service, www.scrippsnews.com.)
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