Three Psychological Biases That Prevent Effective Financial Management by Forbes – Entrepreneurs

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From my experience in financial management and education, I’ve learned a great deal about how people act in these environments and industries. It turns out that there are some interesting mental quirks that occasionally get in the way of their success. 
These psychological “glitches” in the human brain can explain the frustrating actions people sometimes take that can have disastrous consequences.

In order to help you save time and effort trying to figure these out on your own, here are three common biases that financial managers and students should be aware of.

Change Blindness

Change blindness is a phenomenon that was first recognized by the scientific community over a hundred years ago. It’s a term used in psychology to refer to the human brain’s failure to recognize large changes when faced with multiple distractions.

One well-known experiment involving change blindness was conducted at Harvard University in 1999. Titled “Gorillas in our midst,” this study involved several experiments that demonstrated the inability for many individuals to notice minor and major changes when studying a video of people passing balls between each other. 

But how does change blindness affect financial management and what can we do to prevent this psychological glitch from negatively affecting us? The most obvious danger with change blindness is fraud. This mental bias is frequently exploited by hackers who engage in social engineering, which is often utilized in phishing attacks. Combatting this is as simple as limiting access to sensitive information to a handful of trusted individuals and implementing IT security features such as HTTPS certificates to avoid malicious links.

Another threat involves revenue assurance, a form of risk management undertaken by businesses heavily involved with IT and telecom industries. In order to prevent any loss of revenue, financial managers must be aware of any changes in a rapidly shifting information environment. In fact, a recently published survey on revenue assurance by TM Forum states that “Due to rapid changes outside projects, a regular review of controls and KPIs is necessary.” In other words, financial managers need to be constantly involved in and aware of these technologies, or else their brain’s natural inclination toward change blindness can cause their companies to lose significant amounts of revenue.

The Sapir-Whorf Hypothesis

The way our brains process language can also have a significant effect on how it functions. This is the focus of linguistic relativity, which is also referred to as the Sapir-Whorf Hypothesis. Based on the work of linguists Edward Sapir and Benjamin Whorf, this hypothesis states that different languages will cause speakers to experience different realities with their language entirely determining how they think.

Studies conducted in later years have caused modern linguists to tone down these implications, stating instead that language can strongly influence thought rather than completely define it. This has been proven through many experiments, with one such study conducted by John A. Lucy in 2004 showing that English speakers and Yucatec Mayan speakers associate objects differently due to their linguistic deviations.

But how does the Sapir-Whorf hypothesis affect financial management? With the rise of telecommunication technology over the past few decades, businesses and financial institutions now operate on an international scale. According to a 2018 global survey from the ICC, the vast majority of international banks stated that a lack of talented workers and difficulties with compliance of regulations were among their biggest obstacles to international growth. These issues can be largely attributed to differences in language and culture. And if you’re looking for a solution to these problems, it’s as simple as learning another language; that way, you are more aware of these cultural and linguistic differences and how they can affect your thoughts.

The Gambler’s Fallacy

Also commonly referred to as the Monte Carlo fallacy, this is a lapse in logic encountered most often in gambling addicts. However, it’s not uncommon to find otherwise rational and highly responsible financial professionals occasionally suffering from this glitch in their mental processing.

In a nutshell, the gambler’s fallacy is the belief that a random event is more or less likely to occur in the future based solely on the frequency at which it occurred in the past. Its name comes from the mistaken belief by some gamblers that they are more likely to win at a game due to past losses. But how does this affect financial management and what can be done to prevent it?

As it turns out, the gambler’s fallacy is a hot topic in the world of behavioral finance, a field of psychological study. Although math is absolute and free from bias, the people in charge of interpreting math are far from objective and can be highly susceptible to biases like this one.

An example of the gambler’s fallacy at work can be seen in a 2013 behavioral finance study conducted by the IJBM that studied the way investors approached the stock market of Bombay, India. According to their studies, they found that many decisions were being made “based on a wrongly assumed probability of a trend either ending or continuing.”

If you wish to prevent the gambler’s fallacy from affecting you, there are some key phrases and opinions you need to avoid. These include believing that the market is “due” to change based on the fact that it’s acted in one way for so long, as well as any ideas contingent upon markets having a “memory” of past events.

Additionally, humility is a must; you should understand that virtually no one is immune to this foolish line of thinking and acknowledging its presence is the best way to treat it. In fact, having humility and keeping an open mind are the best ways to avoid suffering from change blindness or the Sapir-Whorf hypothesis as well, making it an excellent way to go about your business as a financial manager.

December 14, 2018 at 09:15AM
Forbes – Entrepreneurs