How Biases Can Affect Your Money Decisions

Published on: Jan 27, 2021fb-roundtwitter-roundemail-round
Brain piggy bankMarcie Mintrose

The Story 

We all have biases. Certain ones can make a huge mess out of your finances.

What do you mean?

Your personal beliefs and experiences shape the way you go about your life. Including how you handle your money. Think: how you might shop at one grocery store just because it’s where you always go. That’s the "status quo bias." The downside: when you only stick to the stuff you know, you might miss out on better deals elsewhere.

What other financial biases are there?

There are a lot. But here are a few common ones to check yourself for:

1. Loss Aversion

When you’d rather not play than risk losing. It’s the tendency for people to feel more pain from a loss than they feel joy from a win. 

How it hurts your wallet: It might make you afraid to join the investing game (which always involves some risk). But avoiding potential losses means missing out on potential big wins.

2. Confirmation Bias

When you say: "Don’t tell me what you think. Tell me what I want to hear.” If you only welcome opinions that support yours, you might close yourself off from other points of view. Or the truth.

How it hurts your wallet: You could miss red flags about a hot investment (hi, Bitcoin). Or get bogged down in bad news and bail on stocks too soon. (Psst...here’s when you should actually sell your investments.) 

3. Time Discounting

When you want it NOW. It’s how people prefer taking smaller rewards sooner rather than holding out for bigger rewards later.

How it hurts your wallet: It might make you more inclined to spend money today instead of saving and investing for future goals. But patience is the name of the game when you’re building wealth.

4. Bandwagon Bias

When you saw Cady Heron wearing army pants and flip flops...so you bought army pants and flip flops. But being popular ≠ being right (or fashionable).

How it hurts your wallet: Following the crowd can come with a high price tag. Because popularity tends to drive up prices – sometimes higher than deserved. This could also lead to spending money on things you don't actually value. Meaning there's less left over for the stuff you do.

5. Ostrich Effect

When you’d rather bury your head than get bad news. Spoiler: not hearing it doesn’t make it go away.

How it hurts your wallet: This bias could make you avoid checking your credit card statement after overspending or when money's tight because you're afraid to see the damage.

That's a lot of bad tendencies. What should I do about all of this?

Self-awareness is key. Being mindful of your own behavior and decision making can help you better understand your biases. And how to steer clear of their damaging effects on your money. Here are a few more tips to keep in mind:

  • Learn from your mistakes. Reflecting on past money mess-ups can help you figure out what went wrong. And avoid letting it happen again.

  • Make informed decisions. You can never know everything about a potential purchase or investment, especially exactly when (or if) it'll make you money. No matter how far down the Google rabbit hole you search. But understanding what it is, how it works, and what it’s meant to do can help you decide if it’s worth the costs and risks of buying, regardless of your own biases.

  • Call in a pro. Working with a financial advisor can give you a fresh and expert perspective on your financial strategy and whether it needs to change. Just be sure to carefully vet them, so you're trusting the right person with your money.

theSkimm

Your mental biases affect your finances. And if you’re not careful, they can affect your ability to spend, save, and invest smartly. So check yourself, before they wreck your good decisions.

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Skimm'd by: Ivana Pino, Stacy Rapacon, and Elyse Steinhaus