Biases, we all have them. How we were raised, and our environment can affect the lens through which we see the world. But have you ever stopped to consider what biases you may have regarding money?
Here we’ll explore the top 5 money biases that could cost you money and how to overcome them.
What Are Money Biases?
Money biases are skewed perceptions of how things are. Here are 5 examples.
- Present bias: The tendency to weigh immediate rewards over long-term goals. This can be especially noticeable regarding instant gratification, which is fairly rampant in our modern world.
- Base-rate neglect: The tendency to judge the probability of something happening based on new, easily accessible information while ignoring original assumptions.
- Overconfidence/limited attention span: Overestimating your abilities to make financial decisions.
- Loss aversion/regret/confirmation bias: Being overly fearful of financial losses relative to gains.
- Self-serving bias: Good things happen because of choices you've made, and bad things happen due to things out of your control.
How Are These Biases Harmful?
Have you identified one or multiple biases you have? If you have, it’s OK! Let’s look at why we should avoid these beliefs we may hold.
Present bias can impact your retirement savings by overspending now while not putting away money for retirement.
It’s easy to feel like the future is so far away, and we can permanently save for it “later,” but the truth is that the time to save is always now. It’s far better to be prepared than have the future sneak up on you and realize you’ve spent more than you should have.
Base-rate neglect can cause you to make quick decisions based on emotion - like overselling a stock based on bad news or buying up a new meme stock without evaluating its impact on your portfolio.
Sensationalized news can also contribute to this phenomenon and make you feel anxious.
Overconfidence could lead to you making financial decisions without fully understanding risks or the potential impact - like purchasing a new home, having a child go to college, etc. This can set you back on your financial goals.
Loss aversion can lead to insufficient investment risk, so you might not make large gains on your investments!
Self-serving bias can give you a "rose-colored glasses" look at your finances.
For example, if you end up with extra money in your monthly spending plan, you double down and don't go out to eat as much. This may be true, but when it comes to next month, and you're once again eating out multiple times per week, you may think your overspending is from something else, not because of a change you made.
How Do I Know If I Have One?
The chances are you do! CNBC reports that 98% of surveyed Americans have one or more financial biases. The tricky thing is you may need to know these biases to be able to identify them!
For example, it's natural to feel the urge to "jump ship" when you see bad news about an investment, but don't let loss aversion scare you away!
Take inventory of how you feel when you see particular news articles or check on your investment performance. Or, how do you make financial decisions - do you need to be more confident in your abilities? Are you secretly self-serving?
How to overcome biases
An extraordinary general tactic is to slow down your financial decision-making. Finances and quick, emotional decisions aren't a good combination.
For example, set a rule to always talk to your advisor before changing your retirement savings plan or investment portfolio. Just because Twitter tells you one of your stocks is trending downward doesn't mean it will or that it's time to panic.
Or take, for instance, the bias of base-rate neglect. Instead of only looking at brand-new information, it’s best to balance age-old concepts and general common sense while thoughtfully taking in new information.
Regarding loss aversion, remember that financial investments will have a pattern of ups and downs. While large gambles aren’t always prudent, never taking risks can become problematic. Sometimes you have to sacrifice for a more significant gain in the end.
No matter what, remember what's essential - using your money to achieve your personal and financial goals. Keeping those as your guide while you work with your advisor will help you to see what’s essential and to succumb less often to emotional whims or uneducated decisions.
Having money biases is nothing to be ashamed about. Like most things in life, being aware and consistently making changes will add up in a significant way.
Once you’ve identified your biases and can find ways to overcome them, you’ll be well on your way to financial literacy.