Humans Are Hard-Wired To Make Bad Financial Decisions, But You Can Change That

Biases toward instant gratification, and against taking risk lead many people to save and invest less than they should.

By Jill AmentMay 14, 2018 2:05 pm

Have you ever wanted to save money for – say, a down payment on a new house – and found your attempts at savings were futile? For every dollar that goes into savings, another one goes right out? Or perhaps you have cash sitting in savings, but when it comes to investing it in the stock market, you just can’t seem to pull the trigger on what to buy.

Eshe Nelson, a reporter from Quartz magazine says humans are biologically engineered not to be savvy at financial matters. One reason is known as present bias – a tendency to value what’s happening right now much more than what will or could happen in the future.

She cites the “marshmallow test” in which kids are given a choice between receiving a treat now, or a bigger treat later. Most kids choose instant gratification, and take the marshmallow in front of them, rather than the promise of more, later on.

“Even though you know what the correct decision is for your future, in that moment, you might not be so inclined to make that correct decision,” Nelson says.

Humans are also susceptible to aversion to loss, meaning that we would rather protect what we already have, rather than use our nest egg, say, on a more risky investment.

“You experience a negative feeling of loss twice as much as you would feel a positive sensation from the same gain,” Nelson says. “So the example I use is, if you lose $100, you’re gonna feel much worse about that than if someone handed you $100. This leads to the problem where people go to all sorts of lengths to avoid losses.”

To overcome present bias, loss aversion and other human traits that keep you from maximizing your financial success, Nelson says the first step is to recognize the existence of status quo bias – a desire to keep things the same, as much as possible.

“A really good example of that is when it comes to retirement and savings accounts,” she says. “There’s been a huge wave of governments trying to get people to be part of auto-enrollment plans.”

Forced savings, even of a small amount per pay period, can provide significant dividends at retirement time. To take the next step, Nelson says, go beyond the relatively safe option of auto-enrolling in a savings plan, and choose investments that will yield a higher rate of return.

Written by Shelly Brisbin.