It seems like no matter what you do, your financial situation still seems unchanged, with not much more to contribute to your savings and you wonder, what is going wrong?
You may be suffering thanks to your own cognitive biases – flaws in thinking and judgment that lead us to make the wrong decisions. Get to know some of these common cognitive biases that may be working against the different financial goals you have:
1. For investments: availability heuristic
These sound like big words, but a heuristic is just a mental shortcut we take to make decisions. The availability heuristic is a shortcut that assesses the probability of events by taking into account and sometimes, overvaluing the immediate examples that come to mind.
The availability heuristic comes into play very often when we think about phobias. In spite of your memories of watching Jaws, the odds of a shark killing you are one in 3.7 million as compared to your one in 63 chance of dying from the flu.
So perhaps you’re thinking of joining the tech startup world for the riches and massive IPOs (initial public offering) it seems to promise. Or maybe you’re toying with the idea of playing with stocks and making fast profits in spite of not knowing much about the stock market. Your decisions to take these on may only be because you – and everyone else – have heard of Alibaba Group’s $25 billion IPO or Facebook’s $16 billion IPO and the people who have profited from their shares in these brands. Sure, maybe you also know of the hard work and the late nights that go into creating a successful business. However, the availability heuristic makes us believe that our fates are likely to mirror these success stories that we hear more frequently than the failures.
Similarly, just because your neighbours and their friends tell you they have made loads of money doing multi-level marketing doesn’t mean you should follow their lead and invest your money in it. It’s good to be positive about your own future, of course, but like daydreaming, you need to separate the statistical reality from fantasies of outcomes you hope to have. Recognising the emotions, such as the common one of greed, and doing the actual math is key to stopping yourself being swayed into a wrong investment or financial decision.
2. Curb your poor shopping purchases: choice-supportive bias
This bias may be the reason why you continually use and purchase the same services or goods from the same brand even if there are more cost-effective or better alternatives out there. This bias comes into effect when you tack on positive qualities to choices you made previously, even though those choices or decision actually had gaping flaws in them.
For example, you find yourself having to buy earphones from a particular brand once every three months when the wires snap. But you’re still at it because those earphones worked for you back when you were 14 years old and received your first Discman.
Outsmart your own brain and rid yourself of the nostalgia fluff that’s gathering around your shopping basket. It’s not too much of a challenge to change your shopping habits once in a while and try out different and more long-lasting products that will save you from unnecessary spending to replace them.
3. When negotiating salaries: anchoring
As the term suggests, the anchoring effect takes place when you hold on to that first piece of information you receive onto dear life and make decisions based on that. This cognitive bias is particularly dangerous when you’re shopping for a job and negotiating salaries.
A job interview may seem to be going all well until the HR officer leans back in the chair confidently and throws out a disappointingly low salary offer before asking you your price. In the workings of this cognitive bias, this first offer then becomes the anchor or price point that your mind starts working around. Before you realise it, you have countered with just a slightly higher rate or accepted that salary instead of stating the salary you were thinking of before you entered the interview room.
In anchoring, the first offer establishes the range of possibilities based around it. Unfortunately, these anchor numbers may not be what you’re actually worth. While anchoring first is great, don’t wrap your mind around the other’s anchor number if you’re too late to state what you’re looking for first. You’re likely to have to justify why you’re worth a higher salary when you counter-offer, which is why rehearsing this response prior to your interview is crucial. Never skip out on the negotiation part. You may not get offered what you want, but you’re likely to be paid more if you actually open your mouth to ask.
For more great posts on financial psychology:
Keep reading the BankBazaar blog for more insights into how psychology affects us, and tips to master our cognitive biases.