Why do many people make poor decisions involving their general finances and investments?
There is, of course, no single answer. However, a couple of academics in the United States have examined the veracity of several popular explanations.
The recently published working paper - How Financial Literacy and Impatience Shape Retirement Wealth and Investment Behaviors (http://ideas.repec.org/p/nbr/nberwo/16740.html) - is the result of this fascinating exercise by Justine Hastings, an economics Professor at Yale University, and Olivia Mitchell, executive director of the Pension Research Council at the University of Pennsylvania.
The paper, published by the National Bureau of Economic Research in the US, examines what the authors describe as "two competing explanations" for why many people make "suboptimal financial decisions":
- Financial illiteracy, such as lacking an understanding of simple economic concepts.
- The pursuit of immediate gratification rather than taking advantage of longer-term rewards.
Hastings and Mitchell conclude that impatience is a "strong predictor" of wealth. And their results show while there is a correlation between financial literacy and wealth, the influence of a person's level of financial literacy on investment decisions appears to be weaker.
Robert Powell, writing last month in MarketWatch (US website http://www.marketwatch.com/story/savers-impatience-hinders-retirement-goals-2011-02-07) - the online financial website published by Dow Jones Consumer Media - followed up the Hastings and Mitchell paper by interviewing, among others, Stephen Utkus, director of the Vanguard Centre for Retirement Research in the US.
"Impatience or present bias seems to be an inability to plan for long-term consequences," Utkus is quoted as saying. And he emphasises the need for better training and education to make good financial decisions.
There are some key messages here for individuals when making general financial and investment decisions, beginning with just slow down a little.