The laws of human behaviour influence our financial decisions … and so much more

Jun 14, 2019
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The first law says people will generally stick to the status quo unless influenced to change by an external push or pull, Jim Kilkenny says. Source: Getty.

Recently I came across an intriguing and instructive article written for behaviouraleconomics.com by Aline Holzwarth, in which she put forward three laws of human behaviour to mirror the three laws of motion put forward by Isaac Newton in 1687.

In my previous articles, which you can find at the links below, we have been talking about human behaviour and the impact upon our decision-making by a whole range of cognitive biases. I will pick up again on these biases in future articles but for now I would like to explore these three laws and consider how important they are in understanding why we make the types of decisions we do in everyday life, and includes personal relationships, buying, investing and managing our health.

The first law states that we will not recognise this aberrant behaviour or change our course of action without some external influence – such as getting some advice or getting an effective signal (like an ad) or a reward of some type. A good example is the use of rewards (like loyalty points) and discounts to change people’s buying behaviour for both goods and services. We tend to stick to the same patterns unless we receive relatively strong positive or negative signals to change how we act.

Often the rut in which we find ourselves is surprisingly deep, and occasionally looking up and around and recognising that we may be trapped in the status quo is a very good thing. Commonly, the ‘fuel’ or the ‘friction’ is the primary function of marketing and advertising to either change or entrench existing behaviours for the benefit of the supplier of goods and services. Most humans better understand others than they do themselves.

As with Newton’s three laws of motion, these three laws build upon each other. The second law is that human behaviour is a function both of the person and the environment in which the behaviour is occurring. It is not enough to try to understand what motivates the individual – e.g. are they happy or depressed – but you must also understand the environment with which the person is interacting.

When a person is happy and operating in a positive environment they may be more susceptible to a positive reward and ignore a negative warning, for e.g. encouragement to do more exercise. However, if a person is depressed and in a positive environment then the same reward may in fact produce rebellious behaviour, resulting in even less exercise. Perhaps these laws of human behaviour can help us understand our teenage children or grandchildren more effectively given the wide spectrum of mood swings typical of this age group. Additionally, this law should remind us that making important decisions when in the wrong frame of mind or in the wrong environment (e.g. when share prices are crashing) is seldom a good thing.

Another important personal and environmental issue relates to the age of the decision-maker. As we get older we tend to gradually vary our decision-making processes because of progressive cognitive decline. This process of cognitive decline in decision-making and how to manage it will be the topic of a future article.

The third law is that there are trade-offs and consequences for all decisions. In Newton’s world, his third law was that every action has an equal and opposite reaction. In the world of human behaviour things are never that straight forward. Pure physics is useful in the scientific realm but can only be a guide in the real world of fragile and fickle human behaviour. In this way the third law focuses on trade-offs and unintended consequences.

In larger or smaller ways every decision has trade-offs and consequences. In some cases, we may very carefully weigh up the advantages and disadvantages of a decision and in other cases make the decision very quickly and move on notwithstanding the consequences. In fact, if we did not make many of our decisions relatively quickly, life as we know it would grind to a halt.

The problem is that as humans, we tend to get the important decisions confused with the less important ones and spend insufficient time weighing up the consequences of the more important decisions. These important decisions often involve our health, our finances and our interpersonal relationships. We are, on average, relatively poor at understanding the opportunity costs associated with our decisions – and in particular decisions about our finances. We are inhibited by our cognitive biases and as I’ve said many times in the past, this is where we can be greatly assisted by objective external advice before rushing into important financial decisions.

In over 30 years as a financial advisor, one of the most important roles that I played was helping clients understand the trade-offs and the opportunity costs associated with each decision or choice. A clear understanding of these parameters greatly assists in arriving at a properly informed decision. Because of the law of unintended consequences and lack of perfect foresight any decision may not be perfect but this process is considerably better than rapid-fire, ad hoc and gut-based decisions when you are trapped in your own behavioural paradigm.

So, what can we conclude from all this? I think these simple laws are very useful in providing a framework for understanding human behaviour and decision-making. If you understand more effectively the context in which decisions are made, it is possible you can improve the quality of your decisions.

Does having a good understanding of human behaviour make making the right decision easier for you?

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