This share prices have a 15 minute delay and are shown in the local time of the market in which the quote is displayed.
Before we take any decision, a battle is waged in our mind: emotion versus reason. When our emotions win, we say it’s due to a bias. And what if this happens with decisions about our finances?
David wants to buy a new TV and has been looking at models on sale. Two have caught his eye: the first one is slightly cheaper and at a shop about 20 km away from home; the second one is two blocks away. Even though it means David will invest time and gas to drive to a store 15-minutes away, he decides to go and buy what apparently is the cheapest TV. But if we stop to consider the time and money spent to get to the shop, is it really the least expensive alternative?
David’s decision is based on a cognitive bias, an intuitive and emotional “shortcut” that can trick us when taking decisions about our financial wellbeing. Common biases include the overconfidence bias; the availability bias, or choosing only the most visible option; or the illusion of control bias, or misperceiving our control over certain circumstances.
David’s decision was guided by an anchoring bias because it was “anchored” on the price of the product he wanted without consideration for any other factor.
But how can we prevent cognitive biases from clouding our judgement to take rational financial decisions?
Financial education can help alleviate cognitive biases. Being thoroughly aware of financial risks and rewards will help us take better decisions. For example, to become an investor, having some investment training can help us understand what might be advantageous or detrimental. Being motivated is also key to rational decision-making about our finances, as well as learning how to see problems pragmatically from different angles.
Lastly, we need uniform decision-making processes so we can weigh the advantages and disadvantages of each alternative.
