Most of us have preconceived biases based on our life experience. But if you let your biases affect your finances, it could wind up costing you bigtime.
Here are five financial biases you might not even know you have and how to prevent them from being harmful to your wealth:
Status Quo Bias
It’s the tendency to spend money just to keep up the status quo. When all your friends are eating at an expensive restaurant, you do it, too — regardless of whether you can really afford to do so.
How to fight this bias: Make it much harder, or even impossible, to violate your good intentions. “If you’re going somewhere where your buying juices are likely to be stimulated, leave your credit cards home and carry no more cash than you’ve intelligently decided you should spend,” says Steve Levinson, a psychologist and president of Behavioral Dynamics, in Thief River Falls, Minn.
When we are out shopping, once we touch an item, we become subconsciously attached to it. This is why car dealers want you to test-drive cars.
— Jason Hull, Certified Financial Planner
There’s no shame in declining to keep up the status quo. To help, practice language that makes you feel more comfortable refusing it like: “Sorry, eating at X isn’t in the budget this week” or “Instead of mindlessly shopping, why don’t we bring our lunch and meet in the park?”
When in Rome Bias
This is the habit of purchasing something you really shouldn’t because you’re somewhere that makes the temptation strong. For example, buying that expensive pair of shoes on vacation because, heck, you’re on vacation.
“When we are out shopping, once we touch an item, we become subconsciously attached to it,” says Jason Hull, a Certified Financial Planner and chief technology officer at myFinancialAnswers, a financial planning technology platform. Touching the object makes us think of it as ours, and once we’ve subconsciously crossed that boundary, we’re even willing to pay more for it than we normally would. “This is why car dealerships want you to test-drive cars,” says Hull.
How to fight this bias: Don’t touch whatever you’re thinking about buying. When that’s not possible, Hull advises waiting 15 minutes before actually making the purchase or, for a large purchase like a car or a house, wait a weekend before pulling the financial trigger.
“That will allow time for your prefrontal cortex — the rational, thinking part of your brain — to pitch in and take the reins from your subconscious.”
This is when you spend as you always have, despite a change in your life situation. Maybe you now have two kids in college or you’re married and one of you has either fully retired or is now working part-time but you haven’t changed a thing about your finances to match your current life.
How to fight this bias: Look at the numbers and make necessary adjustments. Can you still afford eating out 10 times per month?
“Face reality,” says Scott Maderer, coach and founder of Christian Stewardship Coaching in Lakehills, Tex. “Assuming you have enough to cover the basics — a roof over your head, lights and food — then it’s a values conversation.”
When the change in your life is less jarring than a layoff and instead somewhat subtle — like paying for college or cutting back on work hours — it often takes people longer to recognize. So compare what’s now coming in vs. what’s going out and how much of a difference the change in your life has created. Then, look for ways to change your spending patterns. You may want to meet with a financial adviser for assistance.
Prince or Princess Bias
This bias can arise if you have a spouse or partner who demands the best in life even when that causes financial problems.
Sometimes in relationships, codependence manifests itself as financial spoiling, explains Maderer. Perhaps one partner indulges the other with fancy meals, shopping trips or expensive jewelry even though such spending isn’t truly affordable.
Do you value your wife’s shoe collection more than your family or your husband’s fishing hobby more than the retirement account? Of course not. But that may be what the checkbook says. “At some point, that’s a problem and someone is at your door repossessing your life,” says Maderer.
How to fight this bias: You and your spouse or partner need to honestly address this problem and come up with a value statement. “Ask yourself: ‘What’s most important: retirement or college saving?,’ for instance. Next, recognize you’re jeopardizing that value and make changes,” says Maderer.
Lifestyle Creep Bias
This is the often unwitting process of allowing your lifestyle expenses to grow more quickly than your income.
“It is so easy for this to happen, and yet it is so detrimental, because it means that you’re not increasing your savings to an adequate level as your income grows,” says Matt Cosgriff, a Certified Financial Planner at BerganKDV in Minneapolis.
How to fight this bias: The best way to combat lifestyle creep is to commit to saving at least half of your raises. Then, allow yourself to indulge with the rest of the raise. This ensures you are increasing your savings each time your income rises, while still providing you with the excitement that comes from being able to spend just a little more on yourself.
After all, tackling biases doesn’t need to mean living like a monk.