Instead of making decisions on sound logic, most of the decisions which we take in everyday life are based on a few mental traps we lead ourselves into believing.
All of us think of ourselves as rational individuals. We like to believe that we make decisions on sound logic, i.e. by properly weighing their pros and cons. However, the truth is far from it. Most of the decisions which we take in everyday life are based on a few mental traps we lead ourselves into believing.
Fortunately, if you understand how these biases work, then you can train your brain to guard against them. Here’s a look at some of the common biases that affect your money life.
1. Outcome Bias
This bias generally occurs where people tend to evaluate decisions based on the result, rather than on the decision process. I see it occur almost every day in the stock market; where while picking a stock, people are so fixated over the returns, that they skip through their basic investing checklist. They fail to look at the company’s financial statements, the industry, the management track-record and, most importantly, the prospects of growth.
How to overcome it: Always remember that you don’t need large wealth to create wealth. You simply need focus and discipline with the money you earn and manage. If you manage to control these two aspects, then you need not control the outcome; even investing Rs 500 every month will help you generate a steady corpus over time.
2. Confirmation Bias
It quite so often happens that when people are going to approach something new – they tend to look at facts which support their views. This is also known as fishing for viewpoints. When we believe that we have made the right choice then, we tend to look and seek information that backs it up.
Confirmation bias often hacks our ability towards proper decision making because we are unable to explore the subject from every angle and choose wisely.
How to overcome it: The best cure for confirmation bias is to be open to the information that you avail. Always be on the look-out for the strongest arguments you can find against your viewpoints and balance them against what you know – if they don’t hold it through, it means you need to let go off the information.
3. The Herd Mentality
This bias is particularly inherent when it comes to making investments. People are often privy to what others are buying and selling – rather than making informed choices on their own. More often than not, purchasing a stock because it worked well for somebody does not necessarily mean it will work for you.
How to overcome it: Going along with the crowd isn’t always the most wrong thing to do. The real mistake is doing without thinking. Before you choose to invest in a stock, do your own research.
4. Sunk-Cost Fallacy
This bias is classic. I have come across several clients who often spend months researching and analyzing a particular sector. But even after they come to a conclusion that this sector is not worthwhile for investing, they are unable to let-go and keep looking investment opportunities. This in their mind, to simply compensate for the effort they have put in.
How to overcome it: The key to beating sunk-cost fallacy is to recognize that what’s gone – is gone! The only question that remains to be answered is whether the decision will cost you more going forward.
In most cases, the key to overcoming a bias is to acknowledge that it exists. The more you are aware of the tricks, your brain can play on you, the better you can be on your guard against them. Awareness is the best way to save money on a tight budget.
(By Rahul Jain, Head, Personal Wealth Advisory, Edelweiss)