You’re in a city you’ve long dreamed of exploring. Relying on your great sense of direction, you head out to immerse yourself in the sights, sounds, and smells—until you’re immersed in the realization that you’re lost.
You’ve fallen victim to a cognitive bias—specifically, the overconfidence effect. Cognitive biases, hard-wired into our brains to aid decision-making, can sometimes hinder rather than help.
The impact of overconfidence on financial planning
Understanding—and outsmarting—cognitive bias is the topic of Episode 4 of Truist Wealth’s podcast, I’ve Been Meaning To Do That.
Everyone is susceptible to these cognitive biases, and we often underestimate their pervasive nature. Overconfidence can distort our worldview, potentially leading to financial missteps such as overtrading or underdiversifying, said podcast guest Dr. Daniel Crosby, a psychologist, behavioral finance expert, and chief behavioral officer at Orion Solutions.
Stay alert for these other biases
Cognitive biases can keep us from making progress on our goals. While our minds are trying to be efficient, these biases are keeping us from thinking or acting in new ways that might lead to better outcomes. Besides overconfidence, other common cognitive behaviors include:
Availability bias
This leads us to focus on easily accessible information, often distorting our perception of risk. As Crosby put it, we pay more attention to what is loud than what is likely.
For example, many people are afraid of flying because they see news footage of plane crashes. But statistically, flying is much safer than driving.
This bias affects our financial decisions by narrowing our information intake. Limiting the information we’ll consider potentially can confirm any misguided beliefs we have about the world. And this can influence how we invest.
Regret avoidance
When we make a decision today based on how we think we’ll feel about that decision tomorrow, we’re experiencing regret avoidance. “When you look at all of these biases, fundamentally, the thing we want to do is move through the world as simply as possible,” said Crosby. “So we try to make decisions that minimize regret.”
As a result, we don’t want to make decisions that we’ll look back on later with regret. These “mental gymnastics,” as Crosby called them, are psychologically taxing.
Status quo bias
“But we’ve always done it that way” is an example of status quo bias. In your brain’s attempt to streamline, it favors doing things the same way over and over again to keep your mind free for more important details. Crosby said this type of bias is your brain telling you, “Well, this has worked before. It’ll work again.”
When it comes to our finances, the downside to status quo bias is that it may prevent us from considering new options that could move us closer to our goals. If you’ve already had financial success, it may be easy to think, “Why change things?”
Ways to help overcome cognitive biases
Despite operating beneath conscious thought, these biases aren’t insurmountable. Strategies to counter them include:
Knowing that cognitive biases exist.
You’ve already taken the first step by becoming aware your mind takes these shortcuts. Knowledge is power. It helps you recognize that your mind is taking shortcuts.
Sometimes you can even turn these biases on their head and make them work for you. For example, podcast host Oscarlyn Elder actively used fear of regret in deciding to take her daughter on a college tour during a busy time for the podcast. “My daughter’s 16,” she told the team. “I have two more February breaks with her, and I’m not going to look back in a few years and wish that I had been with her.”
Crosby pointed to the Save More Tomorrow program, developed by Shlomo Benartzi and Richard Thaler, as an example of using status quo bias in your favor.
“The program used status quo bias to say, ‘Hey, look, people are sort of lazy and locked in, so what if we just locked them into good behavior? What if we just locked them into a program of auto-enrollment and auto-escalation of retirement savings?’ So, in a very real sense, you’re using people’s laziness for their benefit.”
Slow down.
Take a couple of breaths and pause before acting or judging. Cognitive biases happen fast, as a way to streamline our choices. A pause helps us circumvent that. Make a conscious effort to say, “What is truly the best course of action here?”
Seek feedback.
Given the unconscious nature of these biases, it’s important to seek external perspectives. A trusted financial advisor can serve as a voice of reason, providing valuable insights and steering you away from potential pitfalls.
Listen to Episode 4: Hidden biases and what you can do about them of Truist Wealth’s podcast, I’ve Been Meaning To Do That.