When wealth manager and behavioral finance expert Shari Greco Reiches wants to help her clients understand their own decision making processes, she gives them this brain teaser: If a bat and a ball cost $1.10, and the bat costs $1 more than the ball, how much does a ball cost?
Most people, Reiches says, arrive quickly at the same, incorrect answer. Their gut reaction is to say that the ball costs 10 cents. But if this were the case, that would mean the bat costs $1.10, and purchasing them together would cost $1.20 instead of $1.10.
The correct answer is that the ball costs 5 cents, meaning the bat costs $1.05.
The goal of this exercise is to show her clients that if they can get tripped up by trusting their instincts with a simple brain teaser, they are just as likely to make rash decisions when it comes to their investments. People guess 10 cents because it feels right, but "decision making based on feelings rather than facts is going to derail your plans in the future," Reiches tells CNBC Make It.
"People jump to quick conclusions," she says. "A stock is going up? It's going to continue to go up. My friends are making money? I'm continuing to make money. People don't take the time to really think about, 'Does this fit in my plan? How am I going to feel if I lose this money?'"
This exercise is particularly good for investors who are tempted by fast-growing stocks and cryptocurrencies and who are eager to get in on the profits even though, realistically, most of the gains have already been made by someone else, says Reiches, author of the upcoming book, "Maximize Your Return on Life: Invest Your Time and Money in What You Value Most."
"It doesn't matter how smart you are, if you do this mental accounting wrong, those errors are going to derail you," Reiches says. "Instead of jumping to the conclusion, take a breath and take a step back. Think about what you're doing."
Taking time to pause and think out the logical end point of your decisions may save you a lot of pain in the long run, she says. Especially when it comes to how you invest your money.
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