The human brain is arguably nature’s greatest creation. Its ability to recognize patterns, analyze input and respond to those findings has impacted nearly every aspect of life on Earth.
But the brain is far from perfect. One dangerous flaw is called cognitive bias, the tendency for the brain to make an irrational, subjective judgment despite having concrete evidence against that decision. These unconscious biases are so powerful they can overcome not only reason but our values, too. It explains why blonde women in Australia earn an average 7% more than brunettes. And why people with “mature” faces have more career success than baby-faced colleagues, according to a Duke University study.
Cognitive biases impact all sorts of decisions, including those related to money and investing. The first step to getting them under control is awareness. Here are some common cognitive biases that might be undermining your decision-making.
Confirmation – One of the most common biases. This is our tendency to seek out information that supports what we already believe, or want to believe. The result is that we aren’t always open to new ideas or opportunities, including investing early-on in companies with transformative ideas, like Amazon.
Bandwagon – Another very common problem. Our mind tells us that if everyone is doing something, it must be right. Like over-investing in gold or taking a too-big mortgage during the housing boom.
Ostrich – Pretty self-explanatory. When faced with a tough situation, such as an excessive amount of debt, our brain will rationalize pushing off hard decisions and actions – even when that’s counter-productive.
Halo/Horn – First impressions are important. If we have a good first-experience with someone or something, we tend to believe it will always be good, even when that person or thing doesn’t perform up to snuff. The same is true of negative experiences. We allow a bad first experience to permanently color our thinking. I see the horn bias in people who tell me they got burned by the stock market in their early 20’s and thus will never invest again – even as the market has risen steadily in the intervening 25 years.
Planning fallacy – This is why you are always running late. We convince ourselves that we can perform tasks faster than we can. This is dangerous as it can lead us to overpromise and under-deliver.
Affect Heuristic – This is a fancy way of saying that how things are presented makes a big difference to how our mind perceives them. In one study, for example, participants believed that a disease that killed 1,286 people out of 10,000 was more deadly than one with a 24.14% mortality rate. Why? Because the image of 1,286 people dying was more powerful than a statistic. It’s especially important to be aware of this one when it comes to financial decisions, which are packed with numbers that can be presented in various ways by those looking to sell you a specific investment or overall strategy.
Bias Blind spot — Arguably the most dangerous bias. This one happens when we think we’ve overcome our biases and always make totally rational, fact-based decisions. That mindset leaves us terribly vulnerable to making bad calls.
Be mindful of these potential biases as you grapple with important financial matters. Countering cognitive bias with facts and reason will result in better decisions and help keep you on the road to your money goals.