Why We Make Inconsistent Choices (and What to Do About It)

Behavioural economists have long known that we can be inconsistent with our financial decisions, even under identical circumstances. Now they think they know why.

According to a recently published study co-authored by Ryan Webb, an assistant professor at the University of Toronto's Rotman School of Management, we may be able to blame unpredictable activity in the parts of our brains that assess value.

In the study, participants were effectively asked to place bets before each of a series of quick-succession lotteries, while undergoing brain scans.

When the participants made choices that were inconsistent with their previous answers, their scans showed activity in the same regions of the brain normally responsible for making value determinations. In other words, the brain areas that usually make rational decisions made irrational ones, too, suggesting that occasional inconsistent choices are fundamental to the way a typical brain works.

So, what does all this mean for you and your investments?

If your brain, by its very nature, will sometimes steer you toward a choice that runs counter to your typical preferences, you could make a spur-of-the-moment investment decision that you'll later regret.

Thankfully, there are steps we can take to keep our brains in line so that we can avoid investment decisions that are inconsistent with our financial inclinations and goals.

Do a sound risk assessment

By setting guidelines for yourself as to how much risk you can handle in your portfolio, you can steer clear of investments that may sound like good options but carry more (or less) risk than you're comfortable with.

For example, if a particular investment appears to have the potential to pay out big over the long term but fluctuates wildly in the short term, it may not be the right one for you if you plan to cash out those funds soon or just can't stand seeing your portfolio dip too far into the red.

On the other hand, if your investments are intended for your retirement and you've still got a couple of decades to go until you stop working (and you know you're able to stomach the ups and downs of the market), your predetermined risk assessment can help you avoid being overly conservative with your investment choices.

How do you know what's right for you? Our article 4 Questions to Ask Yourself Before You Buy may help you decide.

Determine your asset allocation

Decide how much of your portfolio you want to invest in stocks, bonds and cash — based on your current age and investment goals — and stick to that allocation. You might find it helpful to tune out daily financial headlines if you've got a lengthy investment horizon. For example, if you're invested for the long-term, you've likely got time to ride out any temporary market highs and lows. Even if you're invested for the short-term, your allocation may be more heavily weighted toward assets that aren't affected by daily market fluctuations.

Find out more in What is Asset Mix?

Take time to research

If you're tempted to buy a stock because it's been on a tear, or because someone told you about it, do some digging yourself — and remember that past performance is not indicative of future results. You're in the driver's seat when it comes to your portfolio, and the more you know, the better your decisions can be.

For research tips, check out How to Think Like an Analyst and Own It! 3 Ways to Research Your Investments Like a Boss.