This is the first in a 4-part series about human biases.
Human beings are funny creatures who do some strange things, including making mistakes. But there is some consistency around the mistakes we make. We have several biases that are obvious when it comes to our decision-making. And we want to discuss these biases in relation to financial decisions.
Think about evolution, and what was required of humans before the modern world. Chances are, it was as simple as: see a scary animal – run! See food – go and get it!
Fortunately (or unfortunately, depending on who you ask) things have changed. We are in a modern world now, and our brains are not always wired to make the right choice or right decisions when it comes to money. We’re not necessarily equipped to think about our long-term outcomes. We have such a complex and fast-paced world now, with an influx of information coming in from a variety of sources.
In doing this series of podcasts and blogs, we’re not discounting that we are all human – we have emotions; we make mistakes. We just want to take a step back and look objectively at the common, subconscious mistakes people make; how to be aware of them and how to take action to minimise their effects.
In the first episode, we ask: why do we make these bad decisions in the first place?
Let’s look at some of the different types of bias.
1. Confirmation bias
What is it?
This is the way in which we look for things that confirm what our beliefs already are, and disregard the others. Examples would be surrounding ourselves with people who have similar opinions or decision-making skills as ourselves. It’s easy to do. On social media, for example, we can even filter out the information we receive.
Actively go out of your way to find and research alternative opinions to the ones that you have.
2. Information bias
What is it?
Often, we think that all information is important for decision-making. But there is simply such a large volume of information out there, and it’s not always relevant to us. An example would be reading every single news article about the share market and checking the price of shares daily or even monthly.
Decide what’s relevant. If it’s not, don't even look at it. For example, we know that logging into your super balance every day is not helpful. You only need to look at that amount over the long-term. Statistically, the less you look at those sorts of things, the better decisions you’ll make overall. We like to say ‘don’t get confused by the noise’ which means don’t get caught up on the short-term value of your super or the short-term price of shares. We’re not saying stick your head in the sand – we’re just saying, ask yourself: ‘is this helpful?’
3. Oversimplification bias
What is it?
We often try to make things simpler than they really are. It’s almost the opposite of information bias. A common example is when people ask us what sum of money they will need to retire. But that really depends on their goals and desired lifestyle. People can latch onto one amount and stick to that based on something they’ve seen or read, without working out the actual figure that will suit them.
Make things as simple as you can without oversimplifying it. For things like your retirement, you can’t just pull a figure out of thin air. As your financial advisers, we can calculate it in about 15 minutes with the right information from you. You need to consider what suits your specific needs. And you also need to be comfortable with the fact that there might not always be a right or easy answer. There’s no magic figure or formula – it has to be an educated estimate.
In the upcoming episodes, we’ll talk more about biases, so stay tuned! https://podcasts.apple.com/au/podcast/money-over-50/id1451561647
Dallas Davison, Michael Hogue and Ali Hogue.