All of us think we are perfectly rational beings but how many times have you made a money decision and later wanted to kick yourself for making such an obviously bad choice?
If this after action regret is familiar, you fall into a very unique category called human. In fact, Dan Ariely a behavioural economist even goes so far as to say that “irrationality is the real invisible hand that drives human decision making.”
Ariely and other famous behavioural scientists attribute our natural exuberant irrationality to cognitive bias. Those blips in our cognitive operating system which evolved to keep us safe and preserve our energy by creating operating rules that save us from decision paralysis.
This means when you encounter that vicious tiger while out shopping on the high street or in the mall your brain doesn’t start mentally debating why this unexpected oddity is there and where its came from and instead just sends the run message to your body.
This unconscious override was very effective when we hung out in the wild but now, not always so much and especially when it comes to our money !
While its difficult to see why this awareness of danger could impact our money decisions we have developed a number of other ones which sabotage our rational thinking around our finances.
Let’s take a look at some of the most common ones because once we know what they look like they lose some of their power to hijack our thinking!
Anchoring bias is our tendency to hook on to the first bit of information we have and use that as a reference point for our other decisions.
A pair of shoes that we would never buy because they cost way more than we would ever spend goes on sale for 10% off and all of a sudden they are an “amazing must have bargain” because this is just a “steal” of a deal when compared to the full ticket price. And we end up buying them despite the fact we don’t need red soled leopard print stilettos that cost more than a month’s worth of groceries!
Anchoring puts us on the backfoot when it comes to our money especially when it comes to those big life negotiations like our salary, new car or house purchase.
Knowledge about our tendency to this bias and knowledge through research that proves whether our assumption around the value we are getting is correct. Always do a value check comparison before jumping in!
The Ostrich effect
The “see no evil” bias. This is us sticking our heads in the sand and trying to avoid any negative information that may cause us discomfort.
This avoidance is more than likely going to cost us down the line. And when it comes to our finances, the sooner we take action to address the problem the less it will cost us.
Try and uncover the reason for avoidance, maybe it’s the fear of finding out how much debt you have or how far you are living beyond your means or maybe it’s the overwhelm of not knowing exactly where to start or what to do.
Get an accountability partner or professional support to help you open the pandora’s box and tackle the great big elephant in the box!
Present bias and instant gratification
We have a very hard time planning for the future. It’s so much easier and frankly gratifying to make the spending choices that feel good right now. In fact putting money away for the future feels like a loss which makes delaying gratification feel so much more painful.
Getting to know our future self and what kind of a life we would want for that future self and picturing ourselves living that life builds the desire and motivation. But what builds the self- control and willingness to delay gratification is imagining ourselves NOT having that life and ending up living one closer aligned to our fears. Try that thought on next time the spend or save dilemma appears.
Status quo bias
Even the most adventurous of us has an aversion to change. Sticking with the status quo simplifies our decision making as we don’t have to face making choices.
We stick with the same bank year after year ignoring the poor service and the low interest rate on our bank account or go to the same overpriced dentist, hairdresser, garage mechanic and such just because we are too scared to try someone new and more reasonably priced!
Behavioural science suggests we use another one of our ingrained biases to overcome this one. That is loss aversion. We hate to lose way, way more than we love to win. By framing the current status quo as a loss and all the benefits of the new option as things we are losing out on, we fire up our big aversion to losing out.
This is us wanting to do something because everyone else is doing it even if it leads to us making irrational decisions like queueing for days for the new Iphone or investing in the “next big thing”.
Overcoming the bandwagon effect is all about firstly acknowledging it’s there and becoming aware of when it happens and secondly creating a space and a process to think rationally before acting. This may mean taking the time to properly research the pro’s and con’s and risks and rewards of action including possibly even getting the opinion or input of an unbiased person. Having a clear process to manage the overwhelming appeal of the bandwagon creates a very necessary speed bump to acting irrationally.
Obviously we aren’t going to overcome these biases instantaneously, but knowing they are there gives us the pause to rethink those potentially irrational money actions and the more we practise this the better we get at nipping our self-sabotage in the bud.