A Wealth Advisory Practice

How We Process Information to Make Decisions

· Read in about 2 min · (414 Words)
financial planning behavioral finance

In 2015 I worked on a risk questionnaire that was designed to expand on the more simplistic risk scale that I use as well as is the industry standard. The idea came from a journal article co-written by Dean LeBaron from Batterymarch and published in 1989 in the Financial Analyst Journal.1 As part of introducing the questionnaire, I used what was called the Litterer Perception Formation Model. The idea being that it is important to understand how we process information and make decisions, rational or otherwise. The better we can understand how we make decisions that define our behavior, hopefully the better we can understand what risks we truly are prepared to take.

The following image is a visual interpretation of Litterers perception formation model.2

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Some of the key takeaways from the model:

  • We are selective in what information we process given the overwhelming amount of information available.
  • We filter the information based on past experiences, giving greater weight to more recent experiences.
  • We use heuristics or rules of thumb to help interpret the data.
  • We complete the process our brains will create new information that is logically consistent with existing information.

This understanding is helpful in better discussing what drives an individuals view on risk but it also helps open the topic about how we process information in our daily lives, something that is very important today with the increasing amount of information at our fingertips, including online social media. It helps by asking whether we act in a way that is consistent with how we think we should act?

I seem to always come back to a book written by Dr. Steve Peters.3 In his book he discusses the psychological mind and how it is managed by three different managers: the human (that’s us), a chimp (our emotional thinking machine), and a computer (automatic processing machine plus information storage). Understanding how these 3 parts of the brain interact can be very helpful in understanding how we act and how we might make changes to improve our lives. And possibly answer yes to the question of whether we act consistently with how we believe we should act! That’s very important whether we are building an accurate risk profile, making a purchasing decision, or interacting with social media.

  1. Dean LeBaron, Facilitating a Dialogue on Risk: A Questionnaire Approach, Financial Analyst Journal, May-June 1989, 19-24 [return]
  2. Victor Ricciardi, A Risk Perception Primer, Whitepaper, 2004, 26 [return]
  3. Steve Peters, The Chimp Paradox, Penguin Group, 2011 [return]