In a previous blog, we dipped our toes into the world of behavioral finance by looking at what investors give up by giving into loss aversion. However, today I’d like to cover two other biases that can have consequences for your financial situation.
- Anchoring bias is when we rely too heavily on the first piece of information we find, hear, or experience about a subject. That pre-existing information influences our perspective and decision making, and it can result in working from inaccurate or outdated data.
- Confirmation bias is when we focus on information that supports our beliefs or opinions and ignore what contradicts them. This bias limits our ability to make rational decisions.
Why do I, as a financial advisor, talk frequently about psychology? Other than the fact that I find it fascinating personally, I also believe it’s important to understand our relationship with money and how psychology impacts our financial decisions.
The economy, markets, legislation, and our environment are constantly changing. These things influence strategic money moves, and what was once considered ‘best practice’ decades ago could very well be unwise today – given the current landscape. So, you can see how clinging to old ideas or pre-existing information about investing, for example, could have consequences for your financial potential. That, my friends, is anchoring bias.
A non-financial example perhaps is the ever-changing information for new parents. At one time, parents were instructed never to put babies to sleep on their backs. Now, they’re told never to put babies to sleep on their tummies. Or is it back to no-backs again? I can’t keep up. The takeaway here is that sticking to old information could put yourself or people you love at risk, and as science or circumstances evolve, so should your behavior. When you know better, do better.
Another scenario where biases show up is in marriage. When, where, and how you were raised likely influences how you handle money today. Were your parents big spenders or overly conservative savers? Were you taught to balance a physical check book or avoid the stock market altogether? When two people bring unique backgrounds and experiences into a relationship, it can cause conflict. And if you’ve made up your mind that your partner is irresponsible with money, then confirmation bias will have you finding all supporting evidence to validate that belief.
Just like with the concept of loss aversion, recognizing that these biases are in play is a critical first step. When you notice them impacting your opinions, make a conscious effort to seek new or different information and base your behaviors on rational, accurate perspectives for today.