The Most Common Money Biases
Researchers have found that almost every American has a “money bias,” a term that refers to one’s psychological tendency to view and use money in certain ways. While a minor bias may not be cause for concern, higher levels of bias often correlate with poor credit scores, bad investment decisions, and an inability to properly save for retirement.
The most common money biases include:
The Mental Accounting Bias
People have a tendency to treat money differently depending on where it came from and what they think it should be used for. They might diligently put aside a small, monthly sum of money for retirement but treat anything left as “fun” money. While nobody should lose out on the occasional indulgence, regularly exhausting excess cash could lead to long-term losses.
The Present Bias
This bias is exemplified by a tendency to prioritize short-term rewards over long-term gains. Somebody with the present bias might be inclined to make expensive impulsive purchases while neglecting their retirement.
Base Rate Neglect
Even experienced investors sometimes fear the market, making fast and easy assumptions based on new information. When somebody neglects the base rate, they overreact to new information, buying or selling stock to accommodate for breaking developments. However, base rate neglect can cost investors big if they do not pause to reconsider and analyze their original assumptions.
While some people acknowledge they are not very good at managing money, others believe they are much better investors than they really are. For instance, somebody who occasionally reads about cryptocurrencies might pour money into a new coin to maximize their return on investment, even when the currency is untested and unlikely to succeed.
Many people who take a conservative approach to personal finance are loss averse. Somebody with a loss aversion bias might cling to a spiraling stock to avoid losing money on their original investment, even as its value continues to flounder.
Almost everyone has imagined how different their life could be if only they had invested in Google, Microsoft, or Bitcoin before their respective valuations skyrocketed. This fear of missing out can drive people to invest in accordance with popular trends rather than any well-considered logic.
How to Overcome Your Money Biases
The vast majority of Americans have at least one money bias. Unfortunately, many people with money biases do not realize that these entrenched habits could be robbing them of a comfortable retirement.
You, of course, should never allow a harmful bias to dictate your future. You could:
Evaluate your risk tolerances
Loss aversion and overconfidence can cost investors big if they do not have a realistic understanding of their own relationship with risk.
Create an objective strategy and stick to it
Your financial decisions should be rooted in reality—not emotion. If you believe you are inclined to cling to a floundering stock or avoid “too-risky” investments, you might wish to redirect some funds into an index fund or other asset that historically delivers reliable returns.
Do your own research
Before following the herd or taking the word of a friend, take the time to see where your money is going: research the company, its product, and its long-term strategy, instead of letting yourself get carried away by fears that you could be missing out on the next big thing.
Speak to a professional
Even the most successful investors don't do everything all by themselves. A financial adviser could help you overcome your money biases by designing a retirement plan that takes accurate account of your income, risk tolerances, and long-term goals.
Retirement Planning Doesn’t Have to Be Difficult: Contact Us Today
Moving past your money biases does not have to be difficult. Quraishi Law & Wealth has years of experience helping Arkansans of all backgrounds put their best foot forward, whether to save for retirement or reduce their business’s tax burden.
Please send Quraishi Law & Wealth a message online or call us at 870-275-4304 today to schedule your initial consultation.