If you had to really think about EVERY POSSIBLE THING when making a decision, it would take a lot of time to make even the simplest choice.
Your brain is CONSTANTLY being bombarded with information. You might be focusing on the words you’re reading on this screen, but your eyes are actually seeing MUCH more. You might hear sounds in your immediate vicinity, but your brain is filtering out EVERY sound it can pick up.
Because of the sheer complexity of the world around you and the amount of information in the environment, your brain sometimes relies on some mental shortcuts that allows it to act quickly.
These mental shortcuts, known as heuristics, help in the day to day decision making process, and allow you to function without CONSTANTLY stopping to think about EVERY possible outcome for every scenario.
Most of the time, these heuristics are a great help, saving you time, effort, and energy. Imagine having to analyze every detail in what you should eat for breakfast in the morning? You open the fridge and have to consider EVERY piece of food in there and weigh the pros/cons of consuming each one, and how that affects the rest of your day.
But sometimes, our heuristic tendencies can cause errors (often referred to as biases).
How Cognitive Biases Can impact Your Financial Decisions
When you are making decisions, you like to THINK that you are taking a rational, well-informed approach and evaluating all the information that is available to you, but in reality your past experiences (good or bad) are influencing your brain’s ability to keep you objective.
Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway, gave an entire commencement speech on the matter (“Psychology of Human Misjudgment" at Harvard in 1995). Being able to understand the tendencies that may be affecting your judgment in investments can be crucial to the probability of success in your retirement.
A quick example; anchoring bias. Psychologists have found that people have a tendency to rely too heavily on the very first piece of information they learn, which can have a serious impact on the decision they end up making. (“Oh, the sticker price for this car is $40,000, but I got a great deal on it for only $35,000!”)
If you bought a stock for $100 (after recently seeing that it was trading at a different price before you bought), you might become psychologically fixated on that price for judging when to sell or make additional purchases of the same stock -- regardless of the stocks ACTUAL value based on an assessment of relevant factors or the fundamentals affecting it.
Another bias, confirmation bias, is when you favor information that conforms to your existing beliefs and discount evidence that does not. You can find examples of this in almost ANYTHING today, ranging from politics to religion to science. Confirmation bias is a slippery slope, as tendencies can start a perpetual feedback loop.
If you were to slightly dislike a person, your brain might use biases to see progressively fewer virtues about the person, until you ultimately loathe them. Any opposing information (let’s say you find out the person ran into a burning building and saved an entire family), is glossed over because it runs counter to your initial beliefs, because doubting your current path causes turmoil and stress on your brain, and its always looking for the quickest way to make a decision.
Confirmation bias can greatly effect your ability to make the best decisions for your retirement plan. Investopedia notes that confirmation bias can create particular problems for investors: “When researching an investment, they might inadvertently look for or favor information that supports their preconceived notions about the asset or strategy and fail to register or to under-weigh any or data that presents different or contradictory ideas. The result is a one-sided view and a self-reinforcing loop.”
Everyone exhibits some sort of cognitive bias. And while it might seem like something you can overcome, biases might be hard to acknowledge in yourself.
And if you can’t acknowledge that these biases are effecting/clouding your judgement (especially as it relates to your retirement planning decisions), you could quickly find yourself in a situation you didn’t plan on being in.
Some signs that you might be influenced by some type of cognitive bias include:
- Only paying attention to news stories (or stations) that confirm your opinions
- Learning a little about a topic and then assuming you know all there is to know about it
- Blaming outside factors when things don't go your way
- Attributing other people's success to luck, but taking personal credit for your own accomplishments
- Assuming that everyone else shares your opinions or beliefs
Tips for Overcoming Cognitive Bias
The VeryWellMind website has some great tips on how to overcome cognitive biases:
- Being aware of bias: Consider how biases might influence your thinking. In one study, researchers provided feedback and information that help participants understand these biases and how they influence decisions. The results of the study indicated that this type of training could effectively reduce the effects of cognitive bias by 29%
(Hey, if you’ve read this far, you’re already becoming more aware of cognitive biases, good job!)
- Considering the factors that influence your decisions: Are there factors such as overconfidence or self-interest at play? Thinking about the influences on your decisions may help you make better choices.
- Challenging your biases: If you notice that there are factors influencing your choices, focus on actively challenging your biases. What are some factors you have missed? Are you giving too much weight to certain factors? Are you ignoring relevant information because it doesn't support your view? Thinking about these things and challenging your biases can make you a more critical thinker.
Or, you can schedule a 15 minute phone call with Sam, John, or Ryan - we'll use this time to get to know you and your needs and talk about the retirement planning obstacles you may be facing.