Did you fall for it too?

We do not always behave rationally when it comes to making financial decisions. Behavioural economics and neuro-economics show us how, increasingly, when it comes to spending, saving and investment we do not act according to the ideal model of rationality hypothesized by traditional economic theory, but rather we fall into "behavioural traps" that can lead us to make mistakes.

Most people, for example, struggle to gather and process all the information available correctly. They are prone to changing their preferences depending on how the alternatives are presented to them or they are focused exclusively on short-term gain without considering the long-term consequences of their financial decisions.

Being aware of the main "mental traps" helps us to prevent ourselves from falling into them. Answer the following questions and you will see what some of the most common and widely studied traps are. Don't forget that these traps often work together and at unconscious level...so keep testing yourself!

When interest rates are higher than the average amounts recorded in the past, it is always better to choose a fixed-rate mortgage to protect yourself against the risk of further rate increases.

Correct answer: FALSE. When interest rates are very high, people often choose the safer option of a fixed-rate mortgage for fear that rates will rise further. However, over the long term, rates seem to do the opposite and fall in subsequent years.

A number of studies have shown that people looking for a mortgage seem to focus on the short-term benefits, but not enough on the long-term risks, and so by choosing a fixed-rate mortgage at these times, they bind themselves to very high rates. Fear drives them to make the wrong decisions.

Imagine that you have the chance to play a game you can win in two ways:

you can walk away with €1,500 without having to do anything at all;
you can toss a coin: if it comes up 'heads' you win €1,950, if it comes up 'tails' you win (just) €1,050.

Now imagine that you place a bet and lose. You can choose between two options:

you can pay €750;
you can toss a coin: if it comes up 'heads' you pay €525, if it comes up 'tails' you pay €975.

Most people who have been asked this question have chosen option 1 in the first case and option 2 in the second.

Correct answer: TRUE. In this situation, many people choose to take the €1,500 in the first case, because of their aversion to risk, while, in an effort to minimize their loss, they elect to toss a coin in the second case, demonstrating a greater willingness to take a risk.

This example shows how people's attitudes to risk differ based on whether they are facing a gain or a loss. This inconsistency is known as the Allais paradox: the disappointment caused by a loss is greater than the pleasure of winning the same amount, for example losing €100 makes you unhappier than winning €100 makes you happy!

'House money' is an initial credit that is given by a casino to a player and can only be used to gamble at that casino.

Correct answer: TRUE. This is how gaming operators encourage their customers to gamble since they are not risking their own money, but rather are using that 'gifted' to them. However, what typically occurs is that the players lose the initial sum quickly and at that point feeling that they have lost something, they tend to risk even more (because they are trying to recover the loss), this time round playing with their own money. Rationally speaking, players should not feel as if they have lost since the money gambled was a gift, not their own. Nonetheless, the players feel as if they have lost: this is the endowment effect, whereby people place more value on an object they already own rather than on the same object they have not yet acquired. (E.M. Cervellati, Finanza comportamentale e investimenti. Oltre lʼapproccio tradizionale per comprendere gli investitori, McGraw-Hill, 2012).

An investment in the shares of the company Alpha has a 75% chance of generating a gain; an investment in company Beta leads to a loss in 25% of cases.

It is safer to invest in Alpha than in Beta.

Imagine you buy a baseball bat and ball for €1.10. The bat costs exactly €1 more than the ball. How much does the ball costs?

The ball costs €0.10.

Imagine that you toss a coin 10 times. The first 5 tosses give you the following results:

Heads
Tails
Tails
Tails
Tails

On the sixth toss the result will certainly be heads.

Correct answer: FALSE. This is an example of the gambler's fallacy, which is the belief that previous outcomes determine the next one, when in fact each outcome is independent of the previous ones. In this example, you think that it is more likely that a series of heads will follow a series of tails, but the probability that the next toss will be a heads or a tails is always the same: 50%.

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