We go through each day relying a lot on our instincts – it helps us make decisions, and without them, we would have decision paralysis. The problem is our instincts can be wrong, and it hurts us the most when it comes to making financial decisions. I want to write about our natural biases and their impacts on our finances.
Anchoring: this happens when we make decisions based on the initial piece of information we receive, and we tend to use the initial piece of information to make subsequent judgments.
For example: you walk into a car dealership, and the car dealer puts a $20,000 price tag on a $18,000 car to make you think that the value of the car is $20,000, and when the dealer offers you a discount for $18,000, you thought you got a great deal and never bothered to negotiate more.
The key to beating this bias is to do the research before you make a purchase so you know what you should pay for before being sold to.
Confirmation Bias: is the tendency to look for, and recall information that only confirms your beliefs. So how does this affect personal finance? If you found or heard about a particular company you want to invest in, you might be biased to only look for and remember information about the company that confirms it’s a good investment and overlook any negatives about the company. In a way, you are convincing yourself it’s a good investment.
Fear of Losses: describes our tendency to avoid losses to acquiring gains. Basically, the pain of losing something is twice as powerful as the pleasure of gaining something. No one likes to experience loss, we find it painful. But this fear can cause investors to lose out on opportunities, and to avoid risk all-together when it comes to investing, which can counter to their long-term investing goals. What many investors perceive as “safe” investments such as GIC or just having their money in saving accounts come at a hidden cost: loss of potential returns, which means your money is actually losing money if it’s not even keeping up with inflation. Another example is during the 2008-2009 crash, many investors sold their investments in order to avoid more losses and moved their money into cash, which have also cause them to lose out on significant market gains in the years following.