- When a popular actor endorses a product, fans tend to believe the product is good.
- Following a keto diet as friends are following it without understanding if it is good or bad or its effects on your health.
- When a favourite batsman has had poor form for some time, people assume that he will play well in the next match as it is long since he played well.
Cognitive biases affect our daily financial decisions too. They affect our spends, savings and investments. We must be aware of them and avoid being influenced by them -
Anchoring – You get fixated on the first price you saw for a product. Your buying decision gets affected by this price (less than expected or more than expected). For example, you are shopping for a television set and the first one you saw and liked was for Rs. 25,000. You will tend to look for TVs around that price. There might be TVs with the same features for Rs. 15,000 or TVs that offer better value and more suited to your needs for Rs. 35,0000. But you will try to buy one in the Rs. 25,000 range. This can lead you to a wrong buying decision.
AVOID IT by setting a budget and sticking to it. Buy a product or service that suits your requirements.
Decoy Effect – This is a popular method used by retailers to increase the sales of expensive products. There are two models of a phone brand – A and B. A costs Rs. 9000 and B costs Rs. 13,000. Many might go for A. But if the company introduces a third model , C costing Rs. 11,500 with fewer features than those in B, people would tend to buy C as they assume a balance in terms of price and features.
AVOID IT by researching on the different variants available and buying as per your need and budget.
Bandwagon Effect – Many of your colleagues are buying a new car or the new iPhone, so you decide to take a loan and buy one too or even though you may not need it or your financial situation is such that you should not be taking a loan. The “experts” on TV are sure that the agricultural sector will do well and so we buy stocks of companies in that sector without any research on the stocks on on your portfolio.
AVOID IT by filtering information, looking at things objectively, doing your research. Act according to your financial situation.
Status Quo Bias - We think the present state is the best state. We do not prefer change in our job or food. We are hesitant to switch from our current doctor, financial planner or job even if there are reasons to change. We are hesitant to change the Internet service or gym membership even if there are better offers and better service elsewhere. We do not invest in alternative investment modes but invest in known options like FDs and gold. This bias increases spending and reduces income earning capacity which hurts our finances in the long run. We lose out on good opportunities too.
AVOID IT by starting small. Make small changes. Analyse each scenario objectively. Look at the advantages and disadvantages and then take the optimum decision.
Do you think you have any of these cognitive biases? Let us know how they have affected you.