Wednesday, 27 July 2011

Money, money, money...

The famous ABBA song is about not having money and how great it would be to have more of it. Getting there is not easy, but making some rational decisions would actually be a first step. However, humans tend to be very irrational when it comes to financial decisions. What can we do in order to avoid costly cognitive biases?

PsyBlog author and PhD student Jeremy Dean collected together ten scientifically researched cognitive biases that humans tend to have and how to avoid them.

He describes them on his PsyBlog.

When we want to buy something, we usually choose what we already know, even if something new is cheaper or makes more sense. And we can’t resist once anyway once we see the little word ‘free’, although we know that we will eventually have to pay. But we rather have the pleasure now and postpone the pain to a later point in time. Of course we want the mobile phone for free now, although we just get it in combination with a way too expensive contract that we can’t terminate for the next two years. Once we have made a purchasing decision, we try to justify it and tell ourselves that the decision was right, even if it was not. The phone does not have the features we originally wanted, but hey, it has others that are a lot better. We don’t need them, but hey, they are just so cool. Oh, and looking back, things look a lot rosier than they were anyway. Then when we decide to sell the product again, we have developed a sense of ownership so that we want too high a price for it, which makes it difficult to find a buyer. Of course nobody wants a two year old phone at a price for which they could get a fancy new one! But it does not stop here. We tend to sell our goods at the worst point in time, that is as prices fall, just because we fear losses. The classic: We sell our stock when the price is a lot lower than when we bought it.

Humans are simply not rational when making financial decisions. This is also what Keith Stanovich concludes in his book “What Intelligence Tests Miss”, on which we also published a post here on cut-e scienceblog. Fortunately, Jeremy Dean gives some hints as to how we can avoid these costly cognitive biases.

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