Why smart people make dumb money decisions

Every year thousands of doctors, engineers, and lawyers — some of the smartest working people in the country — end up broke, over-leveraged, or worse. Their intelligence didn't save them. In several studies, very high IQ actually correlates with overconfidence in money decisions, which is a worse financial trait than plain old humility.

The two brains problem

Daniel Kahneman described thinking in two systems. System 1 is fast, emotional, and automatic. System 2 is slow, deliberate, and effortful. Almost every financial decision we encounter day-to-day is processed by System 1 — the discount, the 'last chance,' the ticker going down, the friend's brilliant new investment. By the time System 2 kicks in, the damage is often done.

The common traps

• Anchoring — fixating on the first number you saw (the 'original price' next to the sale price).
• Confirmation bias — seeking information that confirms what you already wanted to do.
• Recency bias — assuming the last few months of market movement will continue forever.
• Loss aversion — feeling losses roughly twice as intensely as equivalent gains.
• Mental accounting — treating a tax refund as bonus money instead of the same dollars you earn weekly.