Sunday, September 20, 2009

Book Review: Snap Judgment - Why our money instincts are bad and how to think better.

Link to review on Amazon.

Snap Judgment is essentially a summary of behavioral finance findings. This field is an extension of the heuristics and biases research program into the realm of finance.

The heuristics and biases program is a deep scholarly literature that shows in great detail how the mental shortcuts that help us survive can also derail our thinking. Recently researchers have applied these principles and expanded the program to include a lot of specific insights into how money affects our thinking and how financial judgments are shaped by our "gut instincts."

The bottom line is very simple, our gut instincts about money are really bad. They create havoc in both our personal lives and in larger scale economies. First implication: knowing about our mental shortcuts should help us make better financial decisions individually and collectively. Second implication: we need to think more with better data and better decision techniques and rely on our gut less in making financial decisions. Third implication: knowing how people react to trends could potentially help predict "anomalies" in financial markets.

These conclusions are argued very strongly over and over again in this book with very specific and detailed examples. Perhaps this is because the gist of Snap Judgment flies directly in the face of other popular books such as Malcolm Gladwell's "Blink" which seem to give the opposite message, that we need to trust our 'rapid cognition' more.

From my reading, when you look closely the evidence falls mostly on the side of the heuristics and biases program. Our gut, especially our "trained gut" serves us very well in certain kinds of decision, to be sure, such as those we evolved good instinct for and those where decisions have to be made faster than we can think effectively. But in other situations, such as when money is involved, and we have the time to make a good decision, this book shows very effectively why our gut misleads us dramatically time and time again.

The unique strength of this book is that it goes into great detail about markets and finance in various areas and applies its findings to very specific cases. This is not yet another general book on decision making, it is extremely focused on financial decisions. It covers in detail the psychology of stocks, bonds, annuities, mutual funds, gambling, CEO behavior, bank runs, and credit of various kinds. The lessons are applied very briefly to other kinds of decisions for comparison and contrast, but the focus is really money.

One small warning, if you have a general interest in decision science or cognitive science and not much interest in finance, much or this book will make your eyes glaze over because the examples are so detailed. That's also why you will find it so great if you want to know in detail how and why our financial decisions go wrong when we rely on our instincts.

If this book does its job, it will make you think when you make financial decisions, and it will help you understand better why money tends to make our judgment bad, and these are very useful lessons.

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