Some time ago there was a lot of brouhaha over RBI reserves and Government raiding aginst it. That created the usual split in opinion amongst the general populace. Some justifying the move over ownership, and others against the profligacy. There were also usual ones who shouted on uses as if they are ultimate owners of the funds. In simple words, the event gave a full display of fallacy against revaluation.

We as humans do face such fallacy against revaluation in our personal lives too. This fallacy against revaluation makes us throw grand parties when our stock becomes a 2 bagger. Some beg to friends for money when they learn of others having huge emergency corpus. This fallacy sometimes gets rationalized as “Right use of funds”. But no matter what flavor of rationalization, this fallacy always wrecks personal finances in the long run.

Intricacies of human fallacy against revaluation

This fallacy can be called as “counting chickens before they hatch”. This fallacy originates because of our default human nature. The brain wants to offload the work of remembering the gains. To offload it pushes one to celebrate the victory. The maximization of value is one such offloading procedure. Our intellect doesn’t suspect this bias. Because this bias originates in our very brain. Lack of diary writing habit also exacerbates this problem. But this bias has another face to it.

The happiness of the gains, makes one lose the judgemental ability.

Another facet of this bias is in the world of numbers. Our brain is not a number cruncher to understand nuanced probabilities of bad events. Without this ability, we cannot be sure about the future at all. This handicap gets forgotten in the face of this bias. If one is throes of emotion hormones, the normal judging functions are all impaired too. This bias is notorious for release of this emotion hormone. The happiness of the gains, makes one lose the judgemental ability. The bias also has other aspects to it.

Financial Intricacies

Apart from not understanding probabilities, we also a whole lot of other weaknesses. One such weakness is total disregard to fundamental finance principle “don’t provide for future gains, but provide for future losses”. To follow this principle in spirit requires a lot of financial maturity. This principle is totally against standard wiring of our brains. Also, the absence of expense tracking exacerbates this problem. With expense tracking, we know our incomes. Since capital gains are tricky, we will tend to ignore it till its realized. WIthout expense tracking, our anchors are in bank balances and CAS statements from depositories.

But Bank and MF Units are assets, not incomes. The assets are accumulations hence will be large in size. This causes our financial bladder to burst. This situation is a result of not seeing our finances as the play between 5 actors of finance – Assets, Liabilities, Networth, Incomes & Expenses.

(See Also: Double Entry Accounting & Personal Finance )

Conclusion

  • The Government raiding RBI for its reserves is just because of the human fallacy of its constituents.
  • There is no such thing called “Right use of funds”. There is only “the use of funds”. Future is the thing that tells whether it was right or not.
  • Everything in the future depends on luck. Hence you can only increase “odds” of luck favoring you.
  • Writing a diary is the only way you can know whether the decision was right or wrong. Diary records rationale behind every decision.
  • Seeing your finances as an interplay of 5 actors helps immensely in managing it.
  • Tracking at least your Income and expenses, helps you overcomes biases of asset balances.
  • Don’t take any decision when you are happy or sad. Emotion hormones cloud judgment.