A few weeks ago, I came across a

question that reveals a huge amount

about the way your brain is wired to

think about money and by extension the

kind of financial mistakes you might be

making right now. I posted this question

as a poll on YouTube and honestly, I was

shocked by the results. I was not

expecting this. But before I show you

the results, I want to see how you do

with this. So, no calculators, no

spreadsheets. I'm just looking for your

initial reaction as the answer should be

clear. Which of these options would

leave you better off after 30 years?

Option A, you have £600 invested now. It

grows at a rate of 7% per year on

average. You get to keep everything at

the end. Option B, you have £1,000

invested now. It grows at a rate of 7%

per year on average, but you have to

give away 40% at the end. Which of these

would leave you better off? Option A,

option B, they're the same or I can't

answer the question. You might want to

pause the video now so you can have a

think about it. At [snorts] first

glance, this probably feels like a

slightly odd question, but the way you

answer it actually tells us a huge

amount. Not just about how your brain

handles compounding, but how it deals

with things like tax and uncertainty. As

a financial adviser, I find the

interactions between psychology and

money absolutely fascinating because

it's often not a lack of intelligence

that leads to financial mistakes, but

the shortcuts our brains use in

situations like this. So, what's the

answer? With option A, £600 growing at

7% per year for 30 years ends up as

£4,567.

With option B, £1,000 growing at the

same rate ends up as £7,612.

Take away 40% and you're left with

£4,567.

Exactly the same. And yet, when I posted

this question to YouTube, of around

2,800 responses, 35% thought option A,

43% thought option B, whilst only 19%

said the same. And these aren't random

people. These are people who watch

personal finance videos, people who are

relatively good with numbers. So, what's

going on here? This question looks more

complicated than it is because of this

compounding part. When you see something

compounding at 7% per year for 30 years,

you think that must be significant. But

there is no way that you're calculating

7% to the power of 30 in your head. But

actually, if both options compound at

the same rate for the same time period,

that entire compounding part actually

just cancels out. So once you strip that

away, this is all you're left with,

which is clearly the same. But if you

don't spot that and you can't use a

calculator, you have to rely on your

intuition to answer this question. And

intuition relies on mental shortcuts.

Shortcuts that are useful most of the

time, but can be very unreliable when it

comes to things like tax and long

investment horizons. So how you answer

this question reveals which mental

shortcuts your brain reaches for first.

If you were pulled towards option A,

it's probably because of loss aversion.

With option B, you have to give away 40%

at the end, which feels like a

punishment. And 40% after 30 years of

compounding could be a hell of a lot of

money. Whereas with option A, where you

get to keep everything, this feels safe,

certain, more secure. We hate the

feeling of losing something far more

than we enjoy the feeling of making an

equivalent gain. That's loss aversion.

So even if we sense that the outcomes

may be identical, our brain says option

A feels better. Here our emotional

reaction is doing the work rather than

logic. But if on the other hand you went

for option B, there's different mental

shortcuts at play. The first is

anchoring. 1 £1,000 is bigger than 600.

And given that these are the first

numbers you see, they stick in your mind

which makes them feel more relevant than

the information that comes after. You

also have 30 years of compounding from a

bigger starting number. You can't

visualize the effects of that in your

head, but instinctively you think that

that should matter. So that by the time

you then get to this 40% tax at the end,

it feels so distant, almost irrelevant

so that you end up underestimating just

how important it is. Your brain thinks a

bigger pot growing for longer must win.

But it doesn't. Again, our instincts are

just leading us astray. And

interestingly, in the comments under the

poll, a few people said that they

initially thought the answer was they're

the same, but then talked themselves out

of it. So, even when our instinct does

point us in the right direction, we

often don't trust it. We overthink, over

complicate things, and end up with the

wrong answer. And this is where things

get really interesting because these

exact shortcuts and mistakes don't just

show up in hypothetical questions like

this. I see them in the real financial

decisions that people make all of the

time. For example, I was recently having

a beer with a mate. Let's let's call him

Alex. Alex is a fund manager. Investing

is what he does for a living. So, after

I'd spent 20 minutes boring him about

how long my kitchen renovation is

taking, we got on to the topic of

finance, as we often do, specifically

pensions versus ISIS. And Alex told me

that he was currently plowing all of his

spare money into his pension instead of

his ISA for various reasons, most of

which made sense. But then he made a

comment that didn't sit right with me.

He said, "I'm also making pension

contributions now because I want to get

that tax relief early so that money has

longer to compound."

On the face of it, this seems to make

sense. Having more money compounding for

longer must be a good thing, right? But

doesn't this sound familiar? Alex has

two options. Option one, he pays income

tax today. Let's keep this simple and

say that that's 40% and he invests the

remaining £600 into a stocks and shares

ISA. Any growth inside the ISA is

taxfree. No tax on withdrawal. He keeps

everything. This is exactly the same as

option A. or he makes a pension

contribution which avoids tax today

which then also keeps more money

compounding for longer but he has to pay

tax when he withdraws it. That's option

B. Alex believes that because the

pension contribution happens earlier and

the tax relief boosts the starting

amount, he must end up better off. But

as we've just seen, tax now versus tax

later makes no difference if the

investment growth in between is the

same. Just think about it like this. If

Alex instead decided to contribute £600

to his stocks and shares Iser now and

assuming he invests that in exactly the

same thing as he would have done with

his pension at any point along this

journey, Alex could take this money from

his ISA and use that to make a pension

contribution. And as long as he gets 40%

tax relief when he does, he'll be on

exactly the same trajectory as if he'd

made that contribution at an earlier

point. This conversation with Alex is

actually what inspired me to come up

with this question in the first place

and see how other people think about it.

But this is where our hypothetical

question differs from reality because

when Alex comes to take money out of his

pension, he's not likely to pay 40% tax

on all of his pension withdrawals. At

retirement, typically you can draw up to

25% of the value of your pension taxfree

up to a lifetime limit of £268,275

and the rest is then taxed at marginal

rates of income tax as you draw it down.

If we assume Alex pays basic rate tax on

all of his taxable pension withdrawals,

that's an effective overall rate of tax

of 15%. Which in the context of our

example would leave him with £6,470

after tax. That's 40% better off than if

you just use an ISER. This demonstrates

how powerful pension tax relief can be.

But Alex already knows this. He knows

that pensions are generally more tax

efficient. He also knows that the more

he can invest earlier on and the more

compound growth he gets, the better off

he's likely to be. But he's conflating

these points and incorrectly assuming

that the earlier he makes pension

contributions, the better off he'll be,

which is not necessarily true. Alex

won't be able to access the money within

his pension until 55 or by the time he

gets there it'll probably be more like

58. But with a stocks and shares ISA, it

is accessible at any point. So if Alex

initially invests his money in an ISA,

that gives him maximum flexibility just

in case he needs to draw that money for

some unexpected reason. But as life goes

on and he then recognizes that he no

longer needs that flexibility, he could

withdraw his ISA and use that to make a

pension contribution and so long as he

gets the same amount of tax relief,

he'll be no worse off. This is an

example of how pensions and ISAs can

work so well when used together. And who

knows, there may even be opportunities

in the future where you can get even

more tax relief than you can now.

Perhaps if you think you'll be in a

higher tax bracket in the future or

you're going to get stuck in the 60% tax

track from 100k or perhaps get to a

point where you start having a child

benefits claw back. If you have ISIS

that you can use to make even larger

pension contributions at those points

and get even more tax relief that may

set you up on an even better trajectory.

Although on the flip side, there's also

risks to delaying. You may end up

getting less tax relief in the future,

perhaps if you drop down a tax band or

legislation changes, which could put you

on a worse trajectory than if you'd made

those contributions today. And there may

be certain opportunities that are only

available today, like making the most of

your employer pension contribution

match. One thing you also need to be

careful of is the pension annual

allowance. Say Alex decided to

prioritize ISIS today. Hopefully after

20 years his ISIS will have grown and

who knows if he's also making additional

contributions. He could have hundreds of

thousands of pounds in his ISIS at that

point. If he then decides that he no

longer needs the flexibility of his ISIS

and he wants to make larger pension

contributions, he may be restricted by

the fact that the maximum that you can

put into a pension each year and receive

tax relief is the lower of 60,000 or

your relevant earnings. In some

situations, you can carry forwards

unused allowances from the past three

tax years. But even if this applies, he

still might struggle to get all of this

money into his pension unless he spreads

it over a number of years. In fact, this

is one of the main reasons he said he

was prioritizing making pension

contributions now because he's on a

trajectory where he's likely to earn

more than £260,000 per year, after which

your pension annual allowance starts to

get tapered eventually down to just

£10,000 per year. So his view is that he

wants to make pension contributions

whilst he still can. As we've seen, 35%

of people went for option A. And I

suspect that those are also the same

types of people who instinctively

gravitate towards ISIS and tend to

disregard pensions because the rules are

simple and you get to keep everything.

Or maybe because ISIS feel more certain

than pensions, which come with more

complexity and rules that seem to change

all the time. I was actually discussing

this with one of my colleagues, our head

of financial planning, and he made the

point that this is exactly why you

should not make decisions like this on

intuition alone. You have to step back

and lay out the problem rationally,

ideally visually like this using your

circumstances. And when you do that from

this distance, it often becomes much

clearer which option is actually likely

to leave you better off. He said this

also applies to people who worry about

future legislation change. Ironically,

that concern often pushes people away

from pensions when in some cases the

argument should actually be to lean

towards them. If you have an opportunity

to secure, say, 40% tax relief today,

that's something that you can lock in.

So, if tax relief were reduced in the

future, well, you've already banked

today's rules. So from that point on, if

you've modeled this out based on your

own personal circumstances, like we've

done here for Alex, you'll probably find

that the government would need to

dramatically change pension withdrawal

rules before you start being worse off

than if you just stuck with an ISA. And

of course, it's worth remembering that

ISIS aren't immune to changes either. I

think this question and the results are

fascinating, not as a test of people's

mass ability, but because of what they

reveal about the mental shortcuts our

brains rely on when making decisions

about things like tax and compound

growth, and just how easily these

shortcuts can lead us in the wrong

direction. Although this is really a

pension versus question in disguise, the

same mental shortcuts and biases show up

across all areas of personal finance.

Sometimes the consequences of them are

small, but sometimes they can be huge.

And the truth is that no matter how

intelligent or well-informed you are,

you can still make mistakes, make poor

decisions if you rely too heavily on

intuition. You can't eliminate these

biases entirely. But one of the best

defenses is simply being aware of them.

Which is why if you want to become a

better investor, you really need to

watch this video here where I do a deep

dive into the most common biases and

where they tend to catch people out.

It's an older video, but I think it's

one of my best. I'll see you there.