Psychological biases about money

Money is a very emotional subject and we often act irrationally when it comes to our personal finances. We tend to gamble, spend a lot, get into debt, live above our means, think short term, and so forth. We are all afflicted by different psychological biases when it comes to money. These biases often lead to bad decision making which can have catastrophic consequences. We can’t eliminate these biases completely but we can do a lot to understand and control them.

So here are some of the most common psychological biases related to money.:

1. Loss Aversion: People feel the pain of losing money more intensely than they feel the pleasure of gaining the same amount. This means they may make irrational decisions to avoid losses.

2. Anchoring Bias: This is when people base their decisions on the first piece of information they receive, the “anchor”. For example, a high original price can make a sale price seem like a bargain.

3. Confirmation Bias: People tend to pay more attention to information that confirms their existing beliefs about a financial decision, while disregarding information that contradicts it.

4. Availability Heuristic: Decisions are often based on information and events that are immediately available to us. For example, a recent news story about a stock market crash may scare someone away from investing, even if the long-term trend is positive.

5. Overconfidence Bias: People often overestimate their knowledge and abilities, leading them to take unnecessary risks or make poor financial decisions.

6. Status Quo Bias: People prefer things to stay the same by doing nothing or maintaining their current or previous decisions. For example, they may stick with the same bank or insurance provider for many years without checking if they could get a better deal elsewhere.

7. Herd Mentality: This is when individuals follow the behavior of the crowd rather than making independent decisions. This is seen in stock market bubbles and crashes.

8. Endowment Effect: People often overvalue what they own, simply because they own it. This can lead to holding onto investments longer than they should or expecting more money for selling used items.

9. Recency Bias: People tend to remember and be influenced by what has happened recently rather than long-term trends or averages.

10. Hindsight Bias: People tend to view events as more predictable than they really were after they have happened. For example, after a stock market crash, they may believe they knew it was coming all along.

11. Mental Accounting: This is when people treat money differently depending on where it comes from, where it is kept, or how it is spent. For example, someone might splurge with a tax refund when they wouldn’t with their regular salary.

12. Gambler’s Fallacy: This is the belief that if a particular event occurs more frequently than normal during a certain period, it is less likely to happen in the future, or vice versa.

13. Present Bias: This is the tendency to overvalue immediate rewards at the expense of long-term intentions. For example, choosing to spend money now rather than saving for retirement.

14. Sunk Cost Fallacy: This is when past investments of time, effort, or money impact future decisions. For example, someone might hold onto a poorly performing stock because they’ve already “invested so much.”

15. Negativity Bias: Negative experiences or fears tend to have a greater impact on a person’s psychological state and decisions than neutral or positive experiences.

16. Inertia: This is a resistance to change, where people are inclined to keep things as they are, even when change would be beneficial.

17. Dunning-Kruger Effect: This is a cognitive bias where people with low ability at a task overestimate their ability.

18. Halo Effect: This is when an overall impression of a person or brand influences feelings and thoughts about its character or properties. For example, a popular celebrity endorsement might make people more likely to buy a product.

19. Self-Serving Bias: This is the common habit of a person taking credit for positive outcomes but blaming outside factors for negative events.

20. Regret Aversion: This bias refers to the anticipation of regret if a certain choice is made, causing individuals to modify their decision-making process

Remember, these biases are deeply ingrained, and everyone has them to some extent. It’s not about completely eliminating them, but recognizing them and minimizing their impact on your financial decisions. We can reduce the negative consequences of these biases by becoming aware of them, educating ourselves, consulting professionals before making big financial decisions, adopting a long term perspective and automating financial decisions as much as possible.