Financial Planning Competency Handbook, 2nd Edition

CHAPTER 87 The Psychology of Decisions: A Short Tutorial

Jason S. McCarley, PhD

Flinders University

Kelly S. Steelman, PhD

Michigan Technological University

John E. Grable, PhD, CFP^®

University of Georgia

Lance Palmer, PhD, CPA, CFP^®

University of Georgia

Dave Yeske, DBA, CFP^®

Golden Gate University

Charles R. Chaffin, EdD

CFP Board

INTRODUCTION

Planning for the medium- and long-term future requires a person to anticipate an enormous range of eventualities, recognizing the turns that events might take, estimating their likelihoods, and assessing their consequences. How many children are my spouse and I likely to have? How long do we expect to remain satisfied at our current jobs, in our current house, or in our current city? What are the chances that one of us will develop a serious illness? What are the chances that both of us develop a serious illness? Some possibilities are near certainties, others only remote contingencies, but any or all might shape the decision maker’s plans.

Not surprisingly, people are prone to mistakes in judgments and predictions, deviating from the rational standards asserted by economic decision theory.¹ These mistakes, though, are not random. We err in predictable ways. What explains these lapses? With enough time and motivation, we can resort to deliberative, effortful reasoning in our judgment and decision making.² Often, though, we bypass this careful approach and default to decision-making shortcuts, which the cognitive psychologists Tversky ...