Overcoming behavioural Biases is very important to manage money prudently. Managing money isn’t just about numbers; it’s also about our thoughts, emotions, and how we perceive financial situations. Often, our decisions on saving, investing, or spending are influenced by certain psychological tendencies, known as behavioural biases.
These biases can sometimes lead us to make choices that aren’t in our best financial interest. By understanding these biases, we can recognize when they’re affecting us and make more informed decisions with our money. Below are the few common behavioural biases.
Anchoring Behavioural Biases: Holding on to the First Number You See
Anchoring bias occurs when we place too much importance on the first piece of information we encounter, and this affects how we make decisions later on. Essentially, we get “stuck” on that initial piece of information, even if it’s not the most relevant or accurate.
Example: You’re in a car showroom, and the dealer first shows you a high-end model priced at ₹ 15,00,000. As you look at its luxurious features, you start to feel that a car might be out of your budget.
Then, the dealer leads you to another car priced at ₹ 10,00,000. After seeing the ₹ 15,00,000 car, this ₹ 10,00,000 option seems like a much better deal. However, both cars are actually overpriced compared to similar models elsewhere.
By showing you the expensive car first, the dealer has created an anchor, making the ₹ 10,00,000 car appear more affordable.
Overcoming Anchoring Behavioural Biases:
Question the anchor: Actively challenge the initial piece of information. Ask yourself:
- “Is this information reliable and relevant?”
- “Could there be other factors I’m not considering?”
Seek out alternative perspectives: Gather information from multiple sources. Don’t rely solely on the initial piece of information.
Take a break: If possible, step away from the decision for a while. This allows you to gain some distance and re-evaluate the situation with a fresh perspective.
Loss Aversion Behavioural Biases: Fear of Losing What You Have
Imagine finding a ₹ 500 note on the street. You’d probably feel a surge of joy! Now, imagine losing that same ₹ 500. That feeling of loss is likely much stronger than the joy of finding it.
That’s loss aversion in a nutshell. It’s the human tendency to feel the pain of losing something much more intensely than the pleasure of gaining something of equal value.
How Loss Aversion Affects Us:
Loss aversion can influence many aspects of our lives:
- Investing: We might hold onto losing stocks longer than we should, hoping for a recovery, rather than cutting our losses and investing elsewhere.
- Risk-Taking: The fear of loss can make us overly cautious and prevent us from taking chances that could lead to significant gains.
Overcoming Loss Aversion Behavioural Biases:
- Reframe Losses: Instead of focusing on what you’ve lost, try to see it as an opportunity to learn and grow.
- Focus on Potential Gains: Shift your perspective to the potential rewards of taking a risk, rather than the fear of losing.
- Practice Mindfulness: By becoming more aware of your emotions, you can better understand and manage the impact of loss aversion.
Understanding loss aversion can help us make more rational decisions and avoid being paralyzed by the fear of losing what we have.
Herd Mentality Behavioural Biases: Following the Crowd
Imagine a flock of birds soaring through the sky. They instinctively follow each other, creating mesmerizing patterns. This natural behaviour, while beautiful to watch, highlights a powerful human tendency: herd mentality.
Herd mentality describes the urge to follow the crowd, to do what everyone else is doing, even if it doesn’t make logical sense.
Example: Equities have been creating a huge buzz. Everywhere you turn on social media, in news articles, and even among friends’ people are excitedly discussing how these will deliver massive returns. The hype is so strong that it feels like a gold rush, with everyone rushing to buy before they miss out.
However, many investors are buying based on this hype and fear of missing out (FOMO), rather than doing proper research. They see others jumping in and feel to follow them, hoping for quick gains.
But by ignoring the risks and not examining the fundamentals, they make impulsive decisions. This behaviour often leads to poor investment choices, driven more by emotion than by careful, informed analysis.
Breaking Free from the Herd:
Do Your Own Research: Don’t rely solely on rumours and social media buzz. Conduct thorough research and make informed decisions.
Question yourself: Ask yourself: “Why is everyone doing this?” “Is there a logical reason behind this trend?”
Diversify Your Investments: Don’t put all your eggs in one basket. Spread your investments across different assets to minimize risk.
Trust Your Gut (Sometimes): If a particular investment doesn’t feel right to you, even if everyone else is doing it, trust your instincts.
Mental Accounting: Treating Money Like It Has Feelings
Ever felt like lottery winnings are “play money” while your hard-earned savings are sacred? That’s mental accounting in action!
We often treat money differently depending on where it came from. Imagine winning a lottery. Suddenly, that ₹ 10,000 feels like a gift from the universe, and you might be tempted to splurge on a lavish vacation or a designer handbag.
But what if you saved that same ₹ 10,000 through months of careful budgeting and scrimping? You might feel hesitant to spend it on anything frivolous. It feels different, almost like it has a different value.
Breaking Free from the Mental Labels:
Recognize the Illusion: Remember that all money is the same. A rupee is a rupee, no matter where it comes from.
Create a Unified Budget: Treat all your income as a single pool of resources and allocate it towards your financial goals.
Focus on Value, Not Source: When making spending decisions, consider the value of the purchase, not how you acquired the money.
Understanding these behavioural biases is the first step toward making smarter financial choices. By recognizing how biases like anchoring, overconfidence, loss aversion, herd mentality, and mental accounting impact our decisions, you can avoid costly mistakes and achieve better money management. Schedule a free consultation call today to gain insights into these biases and empower yourself to make smarter financial decisions.
