What’s the Link between Cognitive Bias and Spending?
Hardly
do we ever acknowledge the fact that our purchasing decisions are governed by
our cognitive biases. Cognitive biases are nothing but mental traps that end up
harming our finances in more ways than we can actually imagine. Let us explore
how in the course of the post.
The Bandwagon Effect
The simplest form of the cognitive bias can be traced in the bandwagon effect. There are so many times when we have blamed ourselves for simply jumping on the bandwagon while making crucial purchasing decisions. These are the times when we are just not drawing a parallel between our purchasing decisions and our needs but are simply inspired by what others are buying.
Think
about buying the latest model of iPhone
just because you have seen one among your many friends buy the same. Think
about making a drastic decision on retirement savings just because your friend
has done the same.
The
bandwagon effect is a result of little or no thinking at all. Needless to say,
it can have detrimental effect on your finances. Take the example of the iPhone.
You may not even need it but are buying it just because others around you are
carrying it. And guess what? You are not required doing anything except
accessing Facebook or getting stock quotes and are not even getting a real
value for accessing the same. Let us tell you that the iPhone device in this
case is a sheer waste of money.
Anchoring Bias
Anchoring bias is something which is an uncharted territory for most of us. Anchoring bias takes place when you are unwittingly relying completely on the first piece of information that you have been able to secure. So, what exactly is it that we should acquaint ourselves with?
Now
let us consider the example of a kindle you are looking for. You come across
the first online store selling it has slashed its price from $300 to $100. Now,
you arbitrarily consider the deal to be a great one without even considering
what the other stores might as well have to offer you!
This
is because of the fact that you have already regarded $300 as the anchorprice. On further investigation you might as well go on
to find stores selling the kindles at lesser prices.
Confirmation Bias
Confirmation bias can be alternately termed as validation bias as well. You might as well like getting your daily dose of news from your social media feeds. However, the problem with this tendency is to prioritize those pieces of information that you would agree with. You are actually seeing facts that consolidate our views and are ignoring those that are conflicting with what we believe to be true. This serves as a big drawback when you are on your way to start a financial venture like a small business.