Page 2 - Wealth-Adviser-Issue-118 (FWP)

ISSUE 118
AUGUST 2025

This tension between immediate de- investing that money. At 7% annual
sires and long-term benefits isn’t a charac- Recent neuroscience returns, that $1,825 yearly coffee budget
ter flaw—it’s hardwired into how our brains research helps explain compounds to over $40,000 after 20 years.
process rewards and time. Traditional Yet the immediate pleasure of the morning
finance assumes we discount future money why these patterns are ritual consistently wins over the abstract
exponentially—steadily reducing its value so persistent. Brain future benefit.
at a consistent rate over time. In reality, imaging studies show This pattern appears across income
most of us follow what psychologists call that immediate rewards levels. High earners often display “lifestyle
“hyperbolic discounting,” where we dra- activate the limbic inflation”—increasing spending to match
matically undervalue rewards that aren’t income rather than directing additional
immediate, but then value them more system—our emotional, earnings toward long-term wealth build-
normally once both options are pushed impulsive brain ing. The underlying mechanism is identi-
into the future . region—while delayed cal: immediate gratification takes priority
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“People can make irrational decisions rewards primarily over delayed rewards, regardless of the
when it comes to money. For example, amounts involved.
behavioural experiments reveal subjects engage the prefrontal
who prefer to have $50 today over $100 in cortex, responsible for The Neuroscience of Now
six months’ time” . This explains why Sarah rational planning. Recent neuroscience research helps ex-
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might choose the holiday over superannu- plain why these patterns are so persistent.
ation savings, yet if asked whether she’d Brain imaging studies show that imme-
prefer $100 in nine months or $50 in three months, she’d diate rewards activate the limbic system—our emotional,
sensibly choose the larger, slightly delayed amount. impulsive brain region—while delayed rewards primarily
engage the prefrontal cortex, responsible for rational plan-
Understanding the Modern Financial Landscape ning . This neurological reality means that purely rational
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Australia’s financial environment makes these be- approaches to financial planning often fail.
havioural tendencies particularly costly. Over 4.7 million
payday loans were issued between 2016 and 2019, worth Cognitive Biases That Compound the Problem
$3.09 billion, with lenders earning approximately 17.8% Financial decisions involve multiple biases working
returns through fees and interest . These short-term loans, together:
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averaging $751 but reaching nearly $1,000 for young Confirmation Bias: We seek information that supports our
Australians aged 18-29, represent hyperbolic discounting in existing spending patterns while ignoring evidence that
its most expensive form. challenges them. A person who believes property always
Despite having one of the world’s most sophisticated outperforms shares will focus on periods when this was true
retirement savings systems, many Australians approach while dismissing contrary evidence.
retirement with inadequate balances. Current data shows
the average superannuation balance for those aged 60-64 Information Overload: “People most often make poor finan-
is $380,737 for men and $300,717 for women . Yet ASFA cial choices when presented with too many options or when
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calculates that a comfortable retirement for a single person information is unnecessarily complex” . The abundance of
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requires approximately $595,000 in savings . investment choices can paralyse decision-making, leading
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These gaps aren’t primarily due to low wages or poor to procrastination or default options that may not serve
investment performance. Australia’s compulsory super- long-term interests.
annuation system has delivered average annual returns of
7.6% over three decades. The problem lies in our collective Recency Bias: Recent events dominate our perception of future
struggle with time preference and the psychological barriers risks and returns. After market crashes, investors often become
that prevent us from making decisions aligned with our overly conservative, missing subsequent recoveries.
long-term interests. Overconfidence: Most investors believe they can time markets
or pick winning stocks despite overwhelming evidence that
The Psychology Behind Financial Decisions professional fund managers struggle with these same tasks.
Hyperbolic Discounting in Daily Life
Beyond payday loans, hyperbolic discounting manifests The Australian Curriculum Response
in countless ways that erode long-term wealth. Consider Recognising these challenges, Australian education
the difference between buying a coffee daily ($5) versus authorities have embedded financial literacy across the

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