5 Behavioral Biases That Can Misguide Our Money Moves

Behavioral Bias #1: Loss Aversion

Feeling the sting of a loss twice as intensely as the thrill of a win––that’s loss aversion at play. (And isn't it just like us to focus on the negative?) Though this behavior is one of the many ways our brain works to protect us, it can ultimately cause a habitual avoidance of risk and/or change.

Example: Refusing to sell and take a short-term loss, even though the market indicates there may be a better option available for a long-term win.

Red Flag: “I’ll hold for now.”

If you’re rationalizing a decision to grasp onto a losing investment, you could be in the midst of a loss aversion bias.¹

Behavioral Bias #2: Confirmation Bias

Confirmation bias happens when we fail to question ourselves to avoid being challenged. Knowing we’re wrong is uncomfortable (and for some, unimaginable), so we seek familiar information that affirms what we already believe. Unfortunately, avoiding an exploration of opposing viewpoints––to remain in our cocoon of perceived safety––could keep us financially stagnant and out of touch.

Example: When creating a personal monthly budget, you find it absolutely necessary to keep your current vehicle instead of researching other options that may be more affordable. You will only drive a (enter car brand here), because everyone in your family owns the same brand. It’s the best––always has been, always will be.

Red Flag: “I know I’m right because…”

That type of affirmative thinking causes you to double down on the confirmation bias. It has you justifying your choices, instead of genuinely questioning them for a more balanced view.²

Behavioral Bias #3: Herd Mentality

The herd mentality can push us to follow the pack and do what everyone else is doing. Instinctively, we can assume the herd “knows best,” so we jump on the bandwagon without thinking twice.³

Example: Several of your industry acquaintances invested in a popular startup, so you rush to back it before researching their business model.

Red Flag: “If I don’t act now, I’ll miss my chance.”

That fear-of-missing-out (FOMO) thinking can highlight the fear-driven quality of herd mentality. This fear can cause impulsive and anxious thoughts to “act now,” to make sure we stay relevant, aren’t left behind, and receive our slice of the pie.

Behavioral Bias #4: Overconfidence

Having confidence in our own knowledge and abilities in the financial world and beyond is fantastic. Don’t change a thing. You’ve earned it. The slippery slope of OVERconfidence occurs when self-assurance shapeshifts into a lack of respect for what we “may not know,” causing a misguided boldness and hastiness in our decisions.

Example: You underestimate what it’ll take to hit certain financial goals because of your successful track record and market savviness. You expect favorable outcomes without weighing all (new) possibilities and facts.

Red Flag: “I’ve done this before…”

Financial decision-making experience, though important, can give us a false sense of control, thus a vulnerability to potential risks.⁴

Behavioral Bias #5: Anchoring

The anchoring bias can cause us to put more weight or value into the first set of information we come across when we’re making a decision. We “anchor” to that first piece of info, using it to evaluate current or future circumstances.⁵

Example: A stock priced at $1,000/share last week is now priced at $300/share, making it seem cheaper or more affordable. If, however, you just priced the stock today and saw it at $300/share (without anchoring to that initial $1,000 price), it wouldn’t necessarily be “cheap” or “affordable.”⁵

Red Flag: “It could be worse, so I should…”

That type of anchoring means we rely on a single set of data points (past or current) as a predictor of future results, leading us to overlook important evidence or trends that should also be considered.⁵

Sources

1. https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/loss-aversion/
2. https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/confirmation-bias/
3. https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/herd-mentality-bias/
4. https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/overconfidence-bias/
5. https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/anchoring-bias/