Our unconscious or subconscious mind is a powerful thing. Much of what we do each day is on auto pilot. When you’re driving your car for example, you don’t consciously apply pressure to the brake or accelerator… you just do it automatically to go with the flow of traffic. This is often how we manage money, with our subconscious or emotional brain often outweighing our conscious logical brain.
The field of behavioural finance explores some of the biases that we may unconsciously apply when make financial decisions (well any decision really but we are here to talk money…)
Hindsight bias: This is where we see past events as being more predictable than they were at the time. I heard this a lot from clients after the 2008/09 global financial crisis. “It was OBVIOUS the stock market was going to crash… we should have got out.” Everything is clear with the benefit of hindsight and yet we often beat ourselves up anyway over decisions we made. This isn’t useful… just accept we made the best decision with the information we had and move on.
Confidence bias: This applies to all areas of our lives where we think we are better drivers, investors, lovers…than we actually are. In financial terms it might be that we get cocky when we buy a couple of shares that do well and believe it is all due to our investing skills.
This is also why we hold on to a poor performing investment. Maybe we made a mistake but we don’t want to “sell at a loss”. Sometimes the investment will come good but often investors ride that mistake all the way to the bottom not wanting to admit they got it wrong.
Self serving/attribution bias: Closely linked to confidence bias, this is where we attribute good outcomes to our own skill and bad outcomes to factors outside our control. We believe we won the tennis match because we played so well but if we lost it was due to unfair umpiring. As investors we believe we gained on the sharemarket due to our superior stock selection but if we lost money it was because of the economy/government/Wall Street fat cats.
Familiarity bias: We tend to be biased towards investing in things we are familiar with. In finance this is often property or, in our super funds, it may be Australian shares. If you are in a super fund that has 60% in Australian shares and 40% in International shares then up to 6% of the total investment may be in Commonwealth Bank. Just one company. (Compared to 5.7% invested in the UK and Japan and 8% in the whole of the USA)…. There are 10,000 shares available in over 40 countries yet our familiarity bias will see us be happy having more money in one bank (and Australians love to hate banks!)
Choice paralysis: This is where we feel we have too many choices and become overwhelmed. It often means we don’t make any choice at all.
This is why many successful people now choose to wear a uniform. Apparantly Barrack Obama wore the same shade and style of suit for years. It was simply one less decision to he had to make each day.
I often find clients feel like this when it comes to superannuation. There are so many funds to choose from and how do you make the decisions? So it’s easier not to make any decision.
Recency bias: This is where we take a recent event and extrapolate it into the future: We believe that the current bad investment market will last forever. Or we believe the mining boom will never end. Either way, it helps to consider history which shows everything moves in cycles.
The herd instinct: I’m not sure if this is exactly a bias but it’s worth examining your motivation for doing something. Herding is when large groups of people respond in the same way to an outside factor. The sharemarket is a classic example, when it is going up and up it seems to gain a momentum of its own with even conservative investors jumping on the investment bandwagon.
For me, I see it most around property. It’s common for people to start their appointment with me asking if they should buy an investment property because “we’re the only one in our group of friends that don’t have one….”
Confirmation bias: this is where we draw a conclusion and then go looking for evidence to support it (often ignoring contradictory evidence). The internet makes this one super easy as you can find pretty much any opinion on any topic! We often prioritise information that supports our opinion and the arguments don’t even have to be logical: they just have to support our view!
Again I see this around property. Clients will come in having found the property and been to the bank to figure out if they can borrow enough. They may have talked to friends (who already have a property) and their accountant. They come in asking for advice but really they just want me to tell them it’s a great idea: they don’t really want it examined!
It’s human nature to behave in this manner and I’m certainly not judging anyone for succumbing to unconscious biases. I know I do it too.
So what can you do to ensure you don’t base your money decisions on some unconscious bias? The first step is becoming aware of them in the first place. Spend time reflecting or writing in your journal some times where you might have been acting on auto pilot. Taking time to review information objectively and without any ego invested in the answer will help you make a conscious financial decision.
Money coaching is another way to uncover hidden biases and behaviours and to move to a more conscious decision making process. To learn to be more mindful with money.