Have you ever avoided checking your bank account balance because you are worried about what you will see? Or have you squandered your better judgment in the case of impulse purchases?
you are not alone. Our emotions can take over and lead us to make suspicious monetary decisions. Understanding why this happens and how to prevent it – starts with understanding behavioral finance.
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Behavioral finance is a research field that explores how psychological factors affect financial decision-making.
“The reason why people often make financial decisions that resist logic (such as overspending, avoiding bills or keeping debt cycles) is not because they are irresponsible, but because emotions like fear, shame and stress are driving behavior,” said Nathan Astle, a certified financial therapist. “It’s about understanding the ‘why’ behind our choices, not just the numbers.”
People tend to have certain cognitive biases, which can negatively affect their financial decisions. Common biases include:
This is a psychological tendency to strongly prefer to avoid losses rather than to achieve equal victory. For example, losing $100 is usually more emotionally painful than getting $100 pleasure.
"Our decisions and actions with money are often driven by fear of losing it rather than taking risks of growth," said Dr. Dan Pallesen, a certified financial therapist.
This often leads people to make overly conservative or even unreasonable decisions with money. For example, you might stick to stocks that lose value longer than stocks that avoid realizing the loss, even if you'd better sell and reinvest funds in well-performing stocks.
The bias of overconfidence is to believe that you know more about a particular topic than you actually know.
This can lead to uninformed financial choices, such as taking too much investment risk without proper research or ignoring the advice of the financial adviser. In other words, overconfident bias can lead to expensive mistakes because your decision is based more on self-assurance than objective analysis or hard evidence.
This is a cognitive bias that makes you too strict on the first message you receive and it is the “anchor” of all future decisions. There are several ways in which an anchor bias can address your financial situation.
For example, suppose you want to buy a home and you will see a list of homes that have lowered prices. You may have to make an offer on this particular home because you can get good discounts and save money. However, further research may reveal that the property is still overpriced on the market or requires expensive repairs to cancel any perceived savings.
As an investor, an anchor bias can occur when you focus on the initial purchase price of a stock or the recent high price, which can affect the investment you make lost, hoping it will rebound.
Doing something simply because everyone else does is human nature, like buying the latest iPhone when your current phone works properly, or waiting in line for a few hours to try a new restaurant because it's popular on social media. This is the mentality known as the herd. But when it comes to financial situations, jumping on the trend can cost you.
For example, during stock market rally, people may be anxious to invest out of fear of disappearance, and during a downturn, they may make sense simply because others are because of other people’s portfolio or risk tolerance.
Familiar bias occurs when people like what they recognize or understand with new or complex situations. This is not always a bad thing, but financially, familiar bias can lead people to ignore better options and thus prefer those that feel comfortable.
For example, you might stick with a traditional savings account that you opened your first account at National Bank 20 years ago, even if you can get 10 times the interest in savings by switching to an online bank.
This refers to treating money in different ways based on where you come from. For example, you might receive a biweekly salary and immediately divide it into various budget categories to avoid overspending. But when you get year-end bonuses or tax refunds, even if you still work for the income you work for, you are more likely to spend that money freely without considering your budget.
The gambler’s fallacy is the possibility that past events will affect future outcomes in a random situation. This is based on the concept of gamblers who lost several consecutive times and think they "should win" victory - so they increase the bet even if the odds are not actually improving.
For investors, this could mean holding stocks because a series of losses means it is likely to rebound soon, or sell stocks because it has been growing for a long time and is likely to drop soon.
Ultimately, this is due to the nature of human emotions and a deep-rooted way to process them to protect themselves.
"Our thoughts are not the bond that we think of good money decisions today. Our thoughts are connected to survive," explains Dr. Palson. "Our ancestors survived the minds to help them avoid danger and roar wildly.
Allowing emotions to occupy the driver's seat while managing money is a dangerous game. It can affect your spending, savings, debt management, investment decisions, and more, ultimately keeping you from achieving your financial goals. But if emotions hinder reasonable financial decisions, it's not your fault.
“We are not rational creatures when it comes to money; we are emotionally thrilled,” Astel said. “Many people carry 'money stories', which are shaped by early experiences, cultural expectations and even generational trauma.”
For example, Astel says if you grow up watching your parents arguing about money, you might subconsciously avoid your adult budget. However, you can take steps to change these behaviors. “The real financial change begins when we recognize these patterns and create space for new, healthier behaviors,” Astel notes.
We ask experts to provide the best tips on overcoming emotional and behavioral biases to make smarter financial decisions. That's what they say.
If you store for a specific goal, such as a child’s college tuition or family vacation, name your savings account to reflect it. This way, whenever you log into a bank account, there is more motivation to continue saving for that goal.
Visual cues are also a great way to inspire you to save and remind you of what’s important, Palson said. For example, look at the child’s photos before discussing family finances with your partner. Record images of your favorite hobbies to a computer monitor to remind you of your expectation of retirement. Create a vision board with friends to view and strengthen the things and values you work for throughout your life.
It is common to focus on losses, but also try to track your victory. “A lot of people monitor their account balances, but they are often scrutinizing things that are beyond their control, such as stock market movements,” Palson said. “Instead, track your savings rate and compare it to your past.”
He said, for example, if you are currently saving 10% of your revenue this year, check if you hit it 15% at the same time next year. Then track your progress in a spreadsheet or diary. "Tracking and seeing progress is a great way to build momentum for healthy financial habits," Pallesen added.
If you are debating an impulse purchase, slap and pause the purchase for 24 hours. This gives you time to think about why you feel like you need it and whether it is really affordable. After a while, you may think that the purchase is not worth it, helping you avoid making impulsive decisions that you will regret later.
Don't be afraid to ask a trusted friend or financial therapist for help to help you navigate the complex feelings associated with finance. They may be able to help you see things from different angles and provide solutions to help you overcome these obstacles.
People often worry about unknown people, but avoiding your bank account balance and budget won’t help you feel safe in currency management. “"Make time to make your financial situation short and innocent sign in. Light the candle, grab the snacks - remove the fear and replace it with consistency and caution," Astel said.
Read more: 5 Psychological Currency Hackers Cut Spend and Increase Savings