Photo by Arif Riyanto on Unsplash
When it comes to making decisions, we as humans can be a little lazy. Not because we are purposefully not willing to put in the mental effort, but because our brains are wired to make decisions quickly, based on the information we have available. Psychologists label these cognitive ‘shortcuts’ as heuristics. While heuristics have given us the evolutionary advantage and have helped us rise to the top of the food chain by helping us solve problems efficiently, they do unfortunately have their downside. They can lead us to make a few errors on the odd occasion. This is especially evident in our financial decision making. Let’s take a look at some heuristics that can lead us to make poor financial choices.
The Affect Heuristic
As the name implies, our affect or emotional state can interfere with our decision making. This heuristic occurs when we are pressured to make an important decision in a limited amount of time. We lean on our ‘gut’ feeling about a particular situation to make an automatic judgement.
While in some cases this heuristic can benefit us, it can also lead us to make bad decisions because our emotional state can change the way we view the risks or benefits of a given situation. For example, when in a good mood, we might assess the risks as being much lower than they actually are. Financially speaking, this could lead us to choose a high-risk investment, for instance, when we are not in a stable enough position to do so and could make us lose money we cannot afford to lose.
The Bandwagon Effect
This heuristic is characterised by our tendency to behave in a certain way or hold certain opinions purely because a large number of people act in a certain way or have particular beliefs – we ‘hop on the bandwagon’.
We subscribe to this thinking because we see others benefit from their actions or beliefs, and although we may also benefit in some cases, this is not a surefire guide for personal choices. It is crucial that we critically analyse our unique circumstance and whether our decision will best serve this.
A good example of the bandwagon heuristic can be seen in people choosing to retire because others around them, of a similar age, are retiring. However, they may not be in the same financial position to comfortably retire or may not be mentally ready to retire.
Decision Fatigue
Decision fatigue refers to us being easily overwhelmed by a large number of decisions and, consequently, making increasingly poorer choices as we make more decisions.
Because decision making utilises higher order cognitive resources, we use up a lot of energy in making decisions. So, when we’ve used up much of our energy and are left tired after a good few mental ‘workouts’, we have limited capacity to make sound decisions and are thus prone to taking this shortcut.
When it comes to finances, of course, the ability to make well-thought-through decisions is crucial. So, if you’ve had a day full of decision-making, we suggest not making important financial decisions towards the end of it. We, at Alex Wardle, make your decision-making process easier by helping you filter out the noise around you as well as the choices that won’t be in your best interest.