When it comes to finances, the human mind plays a significant role in shaping the decisions we make. Our mental state, past experiences, and emotions can often cloud our judgment and cause us to make impulsive decisions that can sabotage our financial goals.

Our financial decisions are often influenced by various cognitive biases that can lead to less-than-optimal financial outcomes. Let’s explore a few of them.

Confirmation bias

Confirmation bias is when we have a strong belief on what we may believe to be true, despite whether or not the data we are relying on to make a decision is really true. In other words, as long as it fits with our views, we may end up relying on the faulty data. As it relates to investors, this bias can lead them to selectively gather information that supports their investment decisions, overlooking warning signs or negative indicators. This can result in poor investment choices and missed opportunities for diversification.

Experiential bias
When memories or experiences from past events make us choose sides even when such a decision is not rational. For instance, a bad experience can lead you to avoid making decisions.

Loss aversion
Loss aversion can make you avoid taking a risk even if it can mean achieving higher returns. You give priority to restraining from experiencing loss rather than experiencing higher returns.

Familiarity bias
The familiarity bias is reflected when we invest our money in an industry we know and understand rather than going after investments from an unrelated field. In this process, we may lose new or innovative opportunities that are revolutionary and that may earn substantial gains. We tend to stick to what we know, versus exploring a new world.

Mental accounting
Your budgeting process or spending habits may tend to vary based on circumstances, meaning that you don’t maintain consistency. For example, you may spend money on a luxury vacation, and when you return home, you revert back to living very modestly.

Mental biases are ingrained in human nature and can significantly impact financial decision-making. Recognizing and understanding these biases is the first step toward mitigating their effects and making more rational and informed choices.

Change the way you do money.

Become more mentally aware so you can make better financial decisions and improve your financial outcome.