Yahoo Finance These Are the 4 Mental Traps Wrecking Your Finances
Americans face slews of economic obstacles that are beyond their control: rising cost of living, lingering inflation, lack of adequate student debt relief and more. But there are ways in which, financially speaking, we can be our own worst enemies. Some of our greatest money problems may be a result of the way we do (or don’t) think.
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Håkan Samuelsson, co-founder of Quantified Strategies, shared four common cognitive biases or mental blind spots that can throw you into financial turmoil.
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Present Bias
It is human nature to, at times, place more value over instant gratification than taking a beat and weighing long-term pros and cons.
Perhaps you pass by a store window and see a gorgeous — and pricey — jacket displayed on a store mannequin. You know you’re on a frugal budget, but the jacket seems to whisper to you that it’s worth the splurge. You put all your diligent financial planning and budgeting on the back burner. The jacket is, in this fragile moment, more important. This is called “present bias.”
“Present bias makes us prefer a smaller reward now over a larger reward later,” Samuelsson said in an email.
Under the persuasion of present bias, you could bust into your savings or bite deeper into credit card debt to buy that awesome jacket. Instant gratification wins, much to your future detriment. But you can cope with present bias in order to make better decisions.
“Overcoming present bias requires discipline and a shift in mindset toward delayed gratification, essential for achieving long-term financial goals,” Samuelsson said.
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Overconfidence Bias
Samuelsson pointed out that many people overestimate their abilities, knowledge and chances of success. Such overconfidence can wreak havoc on your finances.
You may make big investment decisions without adequate research, launch a business without knowing exactly what you’re getting into, or thinking you can somehow time the market — something no one can do.
To overcome what is called overconfidence bias, get second opinions from experts and any financial moves you’re planning to make, look specifically for information that contradicts your opinion, reflect on times you were wrong in the past and think about the consequences if you’re wrong this time.
Anchoring Bias
Just as we may lean on first impressions to formulate our opinions of people (not the best idea), we may over let the first piece of information we receive about a prospective purchase or investment determine whether or not we should buy.
For example, let’s say you see an ad for a credit card that highlights impressive cashback rewards. You think of this fact, but don’t consider other aspects such as, say, the astonishingly high APR. This is called “anchoring bias.”
“Anchoring bias can distort our perception of value, making it crucial to critically evaluate initial information,” Samuelsson said.
To overcome anchoring bias, diligently examine all pieces of information relevant to the purchase or investment you feel strongly about. Be interrogative and set objective criteria for making decisions.
Herd Mentality
You’ve probably heard of herd mentality, which Merriam-Webster defines as “the tendency of the people in a group to think and behave in ways that conform with others in the group rather than as individuals.”
Herd mentality is a problematic mindset in any setting, but it’s especially toxic when it comes to money management. Samuelsson pointed to the dot-com bubble as an example — when investors flocked en masse to buy internet domains, causing related share prices to rise only to later disastrously fall like a house of cards once it was evident that many of these companies were wildly overvalued.
To overcome herd mentality and the risks it carries for your finances, get into tune with what you believe, rather than what others think. Pause and reflect on everything you know about a given investment or buy before taking action, and remember that there have been many times throughout history where a large number of people, however seemingly well informed, were wrong.
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