When it comes to making decisions, big or small, you may not realise that your biases are working in the background, and you need to be aware of this.
A bias is an irrational assumption that affects the ability to make a decision based on facts and evidence. We are all vulnerable to making decisions clouded by prejudices or biases.
Heuristics are the “shortcuts” that humans use to reduce task complexity in judgment and choice, and biases are the resulting gaps between normative behaviour and heuristically determined behaviour (Kahneman et al.). Heuristics are often described as a rule of thumb.
Let’s take a look at how they can affect your decision-making.
Take the example of a particular stock price that has been performing previously. If you assume that it will generate a similar return in the future as well, you will be applying a heuristic pattern.
Below are examples of other heuristics. Do any sound familiar?
Many investors believe that a high return is primarily the result of their skill and neglect other factors. They also assume that negative outcomes might be driven by poor luck.
Sometimes, you may only focus on information or details that confirm your bias or your belief associated with a financial decision. It does not take into account any new developments that may contradict your belief.
This is another bias that can cause you to take the wrong financial decision. You might consider the advice of the first person you talk to or the early information you come across instead of researching all the facts.
Behavioural Economics is an important part of financial planning that you need to consider. You must understand your biases and remove any psychological barriers that may prevent you from maintaining your well-being.
As financial planners, we must also consider ours!