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What’s a Cognitive Bias
Previously, I wrote about the importance of teaching peer review, logical fallacies, and cognitive biases in our homeschool science classes. Today, I want to switch gears just a bit and talk about the importance of cognitive biases on our budgets.
So what are cognitive biases? They are simply ways your mind is preprogrammed to think. These patterns are recognizable, and you can choose to think a different way if you recognize when you are caught in the cognitive bias trap. Cognitive biases really hit our money hard and can make it almost impossible to plan our best budget and stick to it.
Nine Cognitive Biases that are Ruining your Budget
Large family budgets are tight. We have to stretch every penny as far as possible to understand some common cognitive biases will help you improve your life and be a better financial role model for your kids.
Financial confidence starts with a great budget. I know I have looked up several ways to budget, but I have just as many months where I failed at sticking to my budgets and successful months.
Why is it so hard for some of us to stick to a budget? I can’t answer that. I think the answer is going to be different for everyone; however, I do also think that every one of us will easily recognize that we have made bad decisions due to the cognitive biases.
What I can tell you is that with a little education and much reflection, you can do better. By learning the biases, you can recognize them and resist falling prey to their influence, saving yourself money and heartache.
Survivorship Bias -- This is our tendency to overvalue those products (or ideas) that are linked to success. For instance, if a certain brand of shoe was billed as the key to LeBron James’ success, many people would insist on buying that particular shoe, although the tagline is only a marketing gimmick. There may not be anything incredibly different about that shoe than a cheaper brand of shoe.
Authority Bias -- Marketers try to take advantage of this all the time. “#1 Recommended by Doctors” doesn’t mean anything more than its the most recognizable name. I notice this all the time in the OTC medication aisle. My mom told me I had to use Dreft laundry detergent because every other detergent was too harsh for babies’ skin.. I never used Dreft, and I never had problems.
Survivorship Bias and Authority Bias are trying to connect their product with success, implying you will be successful if you use that brand. Don’t choose to pay more for the idea of success.
Framing Bias -- This is all about how the product is presented, either as a loss or as a gain. This is usually presented either in a negative way or a positive way. For example, insurance ads that show you an example of the worst to imply their is a positive gain.
Bandwagon Effect -- This cognitive bias is our habit of making decisions based on the opinions and actions of those in our group. Messages like “Fastest Selling” or testimonials tweak this bias.
Mere Exposure Effect -- This is our tendency to accept products that we repeatedly see ads for. Repeated exposure breeds familiarity, and most people will choose those things they are familiar with. Don’t let commericals breed false loyalty in you.
Denomination Bias -- When you have little denominations ($1 bills, $5 bills, $20 bills) you will spend more money than if you carry large denomination bills. We don’t realize how fast that small amounts add up. Keep a record of every penny you spend. Sign up for my Fill-Your-Register Challenge! Details below.
Anchoring Effect -- Humans latch on the first piece of information, and hang on for dear life. When making big purchases or major decisions, don’t assign more value to a piece of information than it deserves simply because you heard it first.
Recency Effect -- This is almost the same thing as the anchoring effect. Recency is the tendency for some to latch on the last piece of information they heard. When making important financial decisions, weigh each piece of evidence impartially and individually.
Post Purchase Rationalization -- This is convincing ourselves that a bad decision was actually a good one. We have all done it. Impulse purchases are a great example. You get fast food because you don’t have time (although cooking a burger doesn’t take much more time that sitting in the drive through).
When making major money decisions, be aware of humanity’s tendency to fall into these traps. Be honest with your self and self-control will follow.
How can we beat our Cognitive Biases?
This is an easy answer. Be accountable for your purchases. Don’t let them get lost in the ether of the busy day.
If you are like me, and am needing some accountability in your financial life, please download my free printable purchase register. The register is made of 3 x 5 in cards with 3 columns, one for a label (like Groceries, gas, or Starbucks), one for the price of your purchase, and then one for you new balance. It also has a box for the date and the beginning balance. I have designed these cards so that you can cut them into smaller cards that fit in your purse, cell phone case, or wallet and take them on the go. Or if you keep a budget binder, you can stick it in there and then record your purchases from your receipts at the end of the day.
This may seem a bit much, but being aware of how much you spend, down to the penny, will really help you refine your budget. It will show you were you have extra wiggle room and where you have been lying to yourself.
In the amazing book Your Money or Your Life (read my review here) the authors make a compelling case to record every purchase you make. When its rights in front of your face in black and white, you can’t deny it (just don’t fall prey to post purchase rationalization!).
From November 15th to December 15th, I am running a Fill Your Register Challenge. I want this is to be a time when we come together about our relationships with money, what our goals are, how to model financial practices, and how to keep our financial self control while Christmas shopping (I know that’s hard for me). I hope for us all to learn from each other and find support and community. Sign up below to join the challenge!
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