What lies behind a bad financial decision is often our reluctance – or outright denial – to pay attention to information we do not like. Let us tell you why we behave like that and how we can fight it. 

The ostrich effect is a financial bias that is owes its name to the false belief that ostriches hide their heads in the sand to ignore danger or pretend that it does not exist, as a way of protecting themselves. Although these birds do not actually act like that, the idea has been used to describe behaviour that is common in our personal finances and could cause us problems and jeopardise our health and financial well-being.

It is a matter of our brain's tendency to ignore negative information at times of risk or danger, trusting that everything will go well without us taking any action. Thus, we tend to underestimate the potential negative effects of the situation because we rely solely on positive information that strengthens or confirms our view that everything will turn out as planned. This behaviour is also known as normality bias.

The ostrich effect concept was first coined in economics in a 2006 article by the researchers Dan Galai and Orly Sade, who used that term to describe people who avoid knowing the risk of certain financial decisions or situations, i.e. they hide when their finances are adverse or unfavourable.

A clear example to better understand its meaning is those stock market investors, who, according to Dan and Orly, review financial indicators frequently when the market performs favourably, but when the data are negative, they prefer not to consult them so often. We also see this behaviour reflected in our personal finances, when we have debts that we are unable repay and we prefer not to receive information on the situation of our accounts, or when we need to save and reduce our spending but we prefer not to pay sufficient attention to our income.

As we can see, it is very important to have the right information when investing and managing our money. In this article in Tu Futuro Próximo (in Spanish) you can learn about the different types of investment and which one is right for you.

Consequences of the ostrich effect

The attitude of ignoring the financial risks that we run in certain situations does not mean that they disappear, rather the contrary: it could negatively affect our financial health. Some of the main consequences are:

  • Making bad decisions. Without the correct information or avoiding learning about it, the decision may not be the right one. An example of this would be managing our income: allowing ourselves to be tempted by offers or to spend more money on a whim without being aware of the real state of our accounts could undermine our ability to pay our financial obligations (loans, mortgages, rent, bills, etc.), thereby falling into debt and ruining our personal finances.
  • Allowing things to snowball. Bad decisions caused by ignoring useful information could create a snowball effect: something grows bigger and bigger and starts to spin out of control. This is the case with debts. Using credit cards, for example, without taking into account when the repayments fall due, the associated costs of servicing the debt (mainly interest) and our ability to pay, could generate debts that are difficult to cope with in the future. Moreover, these debts could increase if we continue to ignore the information on our finances and do not take the right steps to deal with the situation.
  • Failing to meet financial objectives. Ignoring risks is an attitude that makes it more difficult to achieve our goals. Let’s imagine that a person’s goal is to save, but they do not keep track of the money they are spending on leisure or the prices of the products they buy at the supermarket. As a result, they cannot take measures to reduce these costs and they end up spending more money on their bills and allocating less to savings, thus harming their finances. 

How to fight the ostrich effect?

As is often the case with cognitive biases, the first step in trying to counter them is to be aware that they exist. This will make it easier to avoid falling prey to those errors of judgement that our brain commits automatically in certain situations. The next step is to identify and select in advance what information we need to check when it comes to deciding whether it is something negative or positive. Finally, it is important to act in time when the situation so requires and not to leave financial decisions to chance or in the hands of third parties.

 In this regard, financial education is key, providing knowledge and understanding of economic ideas, financial products and the tools available to make informed decisions, manage our resources better and avoid hiding from our finances.

Do you know what systemic risk is? This Finance for Mortals article will help you understand this concept, which is little-known but very important for our finances.

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