5 Psychological Biases in Financial Decision-Making

Making smart decisions with money isn’t just about knowing the numbers. It’s also about understanding how our brains work—especially when they sometimes lead us astray. Our emotions and thoughts can influence our financial choices in ways we don’t even realize. In his book, “The Psychology of Money”, Morgan Housel talks a lot about this. He says, “Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.” So, let’s talk about some common psychological biases that can affect financial decision-making and how you can avoid them.

5 Common Psychological Biases and How to Avoid Them

1. Confirmation Bias

Confirmation bias happens when we look for information that supports what we already believe and ignore anything that doesn’t. For example, if you think a particular stock is going to do well, you might only pay attention to news that confirms your belief. The problem? This can lead to overconfidence and bad decisions.

How to Avoid It: It’s important to keep an open mind and listen to different perspectives. Before making a big decision, ask yourself: “What if I’m wrong?” Consider both sides of the story, not just the one you want to hear.

2. Loss Aversion

We feel the pain of losing money much more strongly than the joy of gaining it. This is known as loss aversion. Because of this, people often make decisions to avoid losses, even if it means missing out on potential gains. In fact, Housel mentions, “The desire to avoid loss is stronger than the desire to seek gain.”

How to Avoid It: It’s okay to be cautious, but don’t let fear paralyze you. Sometimes taking calculated risks can lead to bigger rewards. Talk with a financial advisor about the long-term picture rather than focusing on short-term losses.

3. Recency Bias

This bias occurs when we place too much importance on recent events and ignore longer-term trends. For example, if the stock market has been going up recently, you might assume it will keep going up forever. But markets go through cycles.

How to Avoid It: Always look at the big picture. Long-term trends are more reliable than short-term fluctuations. Diversifying your investments can help protect you from making hasty decisions based on recent events.

4. Anchoring

Anchoring is when we rely too heavily on the first piece of information we get. For instance, if you hear that a stock used to be priced at $100, you might think it’s a good deal now at $80. But what if $80 is still overpriced based on its current performance?

How to Avoid It: Don’t get stuck on one number or piece of information. Always dig deeper and evaluate the current facts rather than just comparing to past prices or trends.

5. Herd Mentality

Herd mentality is when we make decisions just because “everyone else is doing it.” This happens a lot in investing. People see others buying a certain stock or investing in real estate, and they feel pressured to follow suit, even if it’s not the best choice for them.

How to Avoid It: Remember, what works for one person might not work for you. It’s important to have a personalized financial plan based on your goals, risk tolerance, and timeline.

Being Aware of Psychological Biases

At the end of the day, being aware of these biases can help you make better financial decisions. As Morgan Housel points out, “The most important part of every plan is planning on your plan not going according to plan.” Life is unpredictable, and emotions will always play a role. But by recognizing these psychological biases and working to overcome them, you can make smarter choices with your money.

If you ever feel unsure about a financial decision, reach out to us at Wiser Wealth Management. We’re here to help you stay grounded, stay informed, and keep your long-term goals in focus.

Schedule a complimentary consultation and discover how our services can help you achieve financial success.