Why do financial biases exist?
Our brains are wired to use biases, shortcuts, and heuristics to try and make fast and easy decisions. In the distant past, this mechanism protected us in dangerous and potentially life-threatening situations. Unfortunately, when dealing with money, these quick decisions are often no longer helpful. It is also natural to have strong emotional reactions, like fear, excitement, or stress, when making money decisions. This additional emotional charge can change the way we think about money and lead us to react instead of thinking logically.
For example, we often choose a savings plan just because someone we know has one. We don't take the time to understand if it is the right plan for us. Alternatively, we can miss out on a smart savings plan altogether, simply because we get scared about losing any amount of money and avoid it. These choices are made without ever thinking logically; we simply react from habit, or too much emotional investment. This is why it is so important to learn about areas of financial bias. If we learn about them, we can learn to stop, reflect, think logically, and determine our real needs to make a better choice about the best plan for our needs.
1. Overconfidence can lead to missteps
- Overconfidence means you believe you know more than you do.
- Overconfident people may avoid taking advice from experts.
- Overconfidence can make you believe nothing will go wrong, even without proper planning.
- It may also lead to skipping important steps like checking product features or future needs.
To avoid this, always check facts before making a decision.
- Ask questions like: “Does this plan match my goal?” or “What are the risks?”
- Talking to a financial expert can give you a clearer view.
- They help you see the full picture and stop you from making costly mistakes.
- Remember, confidence is good, but overconfidence can hurt your financial plans.
2. Anchoring can get you stuck on outdated ideas
- Anchoring is when you rely too much on the first number or idea you hear.
For example, if someone once said you need ₹5 lakh for your child’s education, you may keep that number in mind for years—even if fees go up.
- Anchoring keeps you from updating your goals based on new facts.
It can also affect your saving habits. You might keep putting away the same small amount every month, even when your income grows. This can stop you from reaching bigger financial goals. To avoid anchoring, check your financial plans once a year.
- Use tools like savings goal calculators or inflation charts.
- Talk to an advisor to help update your numbers.
- Be ready to change your mind when new facts come in.
- A flexible plan that changes with time will help you stay on track.
3. The fear of letting go
Loss aversion is when people feel more pain from losing money than joy from gaining it. This fear can stop them from taking smart steps. For example, someone might avoid new plans or tools because they worry about losing even a small amount. . But by being too safe, they may miss better options that offer a mix of growth and protection. To handle loss aversion, it helps to understand that some risks are normal. Talking to a financial expert or using calculators can show how safe and useful a plan is. This way, you can make smarter decisions without fear of taking control.
4. Living for today at tomorrow’s expense
- Present bias means enjoying life now, but sometimes at the cost of future goals. Being aware of this can help you find a healthy balance, so you can enjoy today while still saving steadily for what matters most tomorrow.
- This can affect plans like buying a home, retirement, or a child’s education.
- Many people think, “I’ll save later,” but often they don’t.
- One way to stop this bias is by using auto-debit savings tools.
- These tools take out money for savings or insurance plans automatically.
- This means you won’t forget or skip saving.
- Another tip is to imagine your future needs.
- Think about how life will be after 10 or 20 years.
- Having a clear picture of your goals can help you stay focused. Making small savings each month builds up a lot over time.
- This habit helps you live well today without forgetting your tomorrow.
5. Living with herd mentality
Herd mentality means doing what others are doing, without checking if it's right for you. You might see your friends buying gold or mutual funds and feel you should too. But their needs, income, and goals may be very different from yours. Just because something works for others doesn't mean it’s good for you. This habit can lead to buying plans that don’t suit your budget or goals. You may also take more risks than needed just to match others.
To avoid this, think about your personal situation.
- Ask questions like: “Do I need this?” or “Will this help my future?”
- A plan should match your income, age, and life goals.
- It's okay to take advice, but double-check if it fits your needs. A good plan is one made just for you—not copied from someone else.
6. Status Quo Bias: resistance to change
People tend to stick to old habits. For example, someone may only use recurring deposits because that’s what they know.
This can lead to missed chances to grow money.
7. Overanalyzing the latest trends
People may focus too much on recent news. For example, a market drop may cause panic.
This can lead to selling assets at a loss. Instead, focus on your long-term goals. Review your financial plan regularly to stay on track.
8. Misjudging money’s value
- This bias happens when people treat money differently based on its source.
- For example, using a bonus for luxury but not for savings.
- To fix this, treat all income as part of one plan.
- This helps you use money wisely and reach your goals.
9. Too much optimism
- Optimism bias means thinking bad events won’t happen to you.
- This can stop people from preparing for emergencies.
- For example, someone may skip buying health or life cover.
Creating a bias-free financial strategy
- Know your biases: Once you spot them, you can fix them.
- Use tools: Financial apps can help you plan better.
- Talk to experts: They can guide you without emotion.
- Automate your savings: This removes the urge to spend.
- Review your plan: Life changes, and your plan should too.
Conclusion
Behavioral finance biases are natural, but they can stop you from reaching your financial goals. These biases make it hard to think clearly. But once you know about them, you can take better steps.
By building a mix of safe and growth-oriented tools and by keeping emotions in check, your money decisions can improve. The key is to stay aware, stay flexible, and keep your future in mind. You can take charge of your money by making small, smart changes today.
FAQs
What are biases in investment?
Biases in investment are emotional habits or fixed ways of thinking that can lead to poor money choices. You might feel scared to lose money or too excited to gain more, which can cloud your thinking. These feelings may stop you from making smart decisions. For example, you may spend quickly or copy what others do without checking if it is right for you. Understanding these habits helps you prefer to buy plans that match your needs.
What are cognitive biases in investing?
Cognitive biases are thinking mistakes that happen without you knowing. They come from how our brain tries to save time and effort. For example, someone might think they are always right (overconfidence), fear losing money too much (loss aversion), or follow others blindly (herd mentality). These habits can lead to poor money choices. Learning about cognitive biases helps you stop, think clearly, and make better decisions that fit your goals and plans.
What is the present bias in investing?
Present bias means choosing to enjoy something now rather than planning for the future. For example, you may spend money on a vacation today instead of saving it for your child’s school fees. This may feel good now, but it can cause money problems later. To avoid this, you can set up automatic savings or prefer to buy a plan that helps build future money step by step. This way, your future stays safe and secure.
What biases can affect investment decisions?
Biases that affect your money decisions often come from feelings or quick thoughts. These may be based on fear, habits, or what others are doing. For example, someone may avoid new plans because they feel unsure, or follow friends into risky choices without checking. These biases are not facts. They are just shortcuts our mind takes. Once you learn about them, you can make better decisions and prefer to buy savings plans that match your goals.