How exciting was that Superbowl? Could anyone have written a better script?
The greatest quarterback of all time…making the greatest comeback of all time…in the greatest championship game of all time!
And can we also proclaim Lady Gaga’s bungie jump/mic drop/cannon ball combo the greatest halftime show ever?
While historical data may support several of these claims (ie. first overtime in Superbowl history and largest deficit overcome in a Superbowl), others are highly debatable.
For example, was this the greatest championship game?
I’m not nearly qualified enough to answer that question, but I know several folks who may disagree.
Like the folks who thought:
- Just one month ago, Clemson beat Alabama with 1 second left in the greatest College Football Championship game.
- In November, the Chicago Cubs came back from a 3-1 deficit to beat the Cleveland Indians in the 10th inning of game 7 to win the greatest World Series.
- In June, the Cleveland Cavaliers came back from a 3-1 deficit to beat the Golden State Warriors in game 7 thanks to “The Block” in the greatest NBA Championship.
- In April, Villanova hit a game winning 3-pointer at the buzzer to beat North Carolina after they also hit a spectacular game-tying 3-pointer in the greatest NCAA Men’s Basketball Championship.
Is it possible that so much greatness was jam-packed into one year or are our minds playing tricks on us?
We’ve undoubtedly been treated to some exciting sporting events in the last year, but I attribute much of the clamor to “recency bias.”
Keep reading to find out if you are guilty of the recency bias along with several other cognitive biases causing you and me to think irrationally.
Here are 7 Ways Your Brain May Be Costing You Money
Recency bias is “the phenomenon of a person most easily remembering something that has happened recently, compared to remembering something that may have occurred a while back.”
It’s why people leave the movie theater, after seeing La La Land, texting their friends nonsense like, “OMG BEST MOVIE EVA!”
Too young to remember Forrest Gump?
What are you, like 12?” <–proper way to refer to someone younger than you
Kidding aside, the recency bias impacts several areas of our lives – including how we manage our money.
For example, it may explain why millennials are scared to invest in the stock market. The great recession is fresh in our minds and, therefore, it receives heavier weighting in our decision-making than the average returns of the last 100 years.
If you’re one of the millennials who has fallen victim to this fear, then the recency bias may be to blame for your inability to comfortably retire later on. Now, that’s scary.
Mental accounting refers to the inclination to handle money differently depending on where it comes from, where it is kept, or how it is spent.
For example, some of us are eligible for year-end bonuses while others are set to receive tax refunds. In both cases, people are expecting a windfall (more cash than usual coming in). There’s a good chance we’ll all use the money differently; but, what’s interesting is that – what we do with the money may depend less on our financial situation and depend more on semantics. Those receiving refunds may be more likely to pay down debt while those receiving bonuses may be more likely to go on vacation or buy a gift.
As Ezra Klein put it:
“Reimbursements send people on trips to the bank. Bonuses send people on trips to the Bahamas.”
Harvard researchers tested this by giving students $25 and asked them to either spend it at the school store or save it. The money was framed as a “bonus” for one group and a “rebate” for the other group.
What were the results?
79% of participants receiving rebates saved all of the money compared to 16% of the participants receiving bonuses.
Wait, but why?
Bonuses feel like we’re moving to a wealthier state whereas refunds feel like we’re returning to where we were.
This year, as you’re thinking about what to do with your refund or bonus, consider where you are financially and the next goal you’re working towards.
Here’s a reminder of an acceptable order of operations:
- Save $1000
- Payoff credit cards, medical bills (smallest to largest)
- Build a cash cushion (3 months of expenses)
- Contribute to your 401(k) up to your employer’s match
- Payoff car loans, student loans (smallest to largest)
- Save for things you want:
- Down payment for a house (20%)
- Roth IRA
- 529 Plan
- Max 401(k)
- Travel, furniture, etc.
- Payoff mortgage
- Give generously
Related article: The Legend of the Man in the Green Bathrobe
The endowment effect describes how people will often value something more because they own it. It can be seen in transactions as simple as trading players in fantasy football to transactions as complex as selling a house.
How many times have you seen someone list their house for well above the market value? The house sits on the market for several months or years because the owner’s sense of value is blurred. It’s ironic because they usually bleed money via monthly mortgage payments and ultimately sell at the market value (costing them more money than if they priced it appropriately from the beginning).
Sunk Cost Fallacy
In theory, rational decisions should be made based on future value and expenses; but in practice, our decisions are often emotionally tied to costs we have already incurred and investments we have already made. The costs which have already been incurred are “sunk costs” and shouldn’t be factored into any future decisions.
The sunk cost fallacy is all around us.
- Friends stay in bad relationships simply because of how long they have been together
- You continue eating even though you’re full because to leave it would be a waste of money
- Governments and companies justify moving forward with bad projects because significant investments have been made
A great way to counter this way of thinking is to ask yourself if you would do something the same today.
If I’m searching for stocks to buy, would I want the one I currently own for the price it’s currently at?
Or let’s say I became an accidental landlord because I owned a house in Texas and then moved to Virginia. If I were to select rental properties to buy today, would I realistically choose one in Texas? No.
Key advice: Cut your losses.
Related article: Dump Your Girlfriend and Eat Whichever TV Dinner You Want
My biggest complaint with modern-day consumerism is the desire to find “deals.” People purchase goods and services, not because they need them or even want them, but because they’re a bargain.
A pair of jeans on sale for $50 (originally $250) are far more attractive than a pair of jeans that have always been $50.
Why? Because it’s a deal!
This sneaky tactic is known as anchoring. Our minds have a tendency to rely too heavily on the first piece of information we have and then make subsequent decisions with the “anchor” in mind.
If you look at the price tag of any item, the MSRP or Regular Price is nothing more than an anchor. Knowing this, you should never consider the original price of anything when determining if it’s worth purchasing.
The good news is that you can also use anchoring to your advantage. At the beginning of a negotiation, start with a number that is higher than what you actually want or expect and you’ll likely wind up at your desired number.
The bandwagon effect, also known as herd mentality, causes people do something just because many others are doing it. Perhaps it’s most noticeable in sports when a team starts winning, but it also applies to money. Herd mentality could cause you to buy something regardless of whether you need it, can afford it or even want it. It could also explain how we end up with asset bubbles.
As I pointed out in 5 Big Mistakes Broke People Make With Their Money: Normal is broke, so don’t be normal. And don’t justify your actions by the fact that others are doing it.
The gambler’s fallacy is the belief that if something happens more now then it will happen less later.
If you have ever walked by a roulette table, you know that casino’s play into this mistaken belief. The gambler’s fallacy is also known as the Monte Carlo fallacy because, over 100 years ago at the Monte Carlo Casino, the roulette ball fell on black 26 consecutive times (very improbable). Gamblers lost millions of dollars because they incorrectly assumed there was a higher probability the next ball would land on red. And it never did.
The gambler’s fallacy may also be to blame for investors’ feeling that we’re due for a stock market correction. They believe this because we’re 8 years into a bull market (lots of black), so we’re probably due for some red.