Logic doesn’t always take the lead when it comes to money. In fact, according to behavioural finance – a field that blends economics and psychology – our emotions and mental shortcuts often lead us to make irrational and bad financial decisions. We need to understand these biases to take a step towards having smart financial habits.
Loss Aversion
The most common bias that makes people make bad money decisions is loss aversion. It’s the tendency to fear losses more than we value gains. This is why some investors would panic-sell during market downturns or hold onto losing assets for far too long. How to solve this? Simple. Just focus on long-term goals and use data-driven strategies rather than emotional reactions. Consulting a financial advisor or setting automatic investment rules can help avoid impulsive decision making.
Anchoring
Another pitfall is anchoring. It’s the behaviour of relying too heavily on the first piece of information we see or receive. For example, a house’s listed price or a stock’s previous high. Information like this can cloud judgment and lead to unrealistic expectations. To counter this, it’s important to compare multiple data points. Do not rely on the first one. Be willing to adjust expectations as new information appears.
Herd Behaviour
Herd behaviour is a prevalent action amongst people. It’s the urge to follow what others are doing. Whether it’s buying a trending stock or a brand new device, or anything else that many people want. Following the crowd often leads to costly mistakes. The solution to this behaviour is simply taking the time to pause and think whether this decision can help your financial goals or not.
Recognising these three traps can help you think more critically and act more rationally when it comes to making money decisions. The better you understand these traps, the more in control you become.
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