Personal Finance

Some of your behavioral biases could be causing you more financial harm than you realize, study suggests

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Key Points
  • There's a correlation between high levels of some biases and unfavorable financial outcomes, research shows.
  • These connections hold true even when controlling for demographic information like age, education or income.
  • Even if you can't eliminate your biases, there are ways to minimize how they impact your financial decisions.
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Some of your behavioral tendencies might be causing harm to your financial wellbeing, research suggests.

Regardless of factors such as age, income and education, there's a connection between certain biases and financial health, according to a Morningstar study about behavioral finance released on Tuesday. The research shows that high levels of these biases (noted below) correlate with things like lower checking and savings account balances, smaller retirement savings and lower self-reported credit scores, among other measures of a person's financial picture.

"Most Americans suffer from these biases in one form or another, and they are directly related to financial outcomes," said Steve Wendel, head of behavioral science at Morningstar.

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The research, based on a survey of 1,211 participants, focuses on four common biases:

  • Present bias: Tendency to overvalue immediate smaller rewards at the expense of long-term goals.
  • Base rate neglect: Tendency to ignore the probability of something happening and instead judge its likelihood by new, readily available information.
  • Overconfidence: Tendency to overweigh one's own abilities or information when making an investment decision. 
  • Loss aversion: Tendency to be excessively fearful of experiencing losses relative to gains.  

Most survey respondents — 98% — exhibited at least one of the four biases highlighted in the research. Participants were assessed for their financial health as well as the existence of biases, and then rated on how minimal or severe those tendencies are. 

Overall, the lower the level of bias, the better the financial wellness exhibited. For example, people with low "present bias" are 7.5 times more likely to plan for their future and 2.4 times more likely to pay their bills on time than individuals with a high score in that category, the research shows.

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How behavioral bias impacts asset valuations, risk and reward choices

Younger survey participants showed the highest level of overconfidence bias, compared with their older counterparts.

At some point in the next few months, Wendel said, Morningstar plans to offer a free online tool that will help investors assess their own biases.

While you may not be able to eliminate your own biases, there are things you can do to minimize their potential to negatively impact your financial life, Wendel said. For instance, you can set up what he calls "decision-making speed bumps."

"It's doing something to slow the decisions down," he said.

For example, before making a major change to your investment portfolio, you could employ a three-day wait rule (not acting on a decision for three days) so you don't act on impulse.

Additionally, it's best to ignore the daily noise. That is, avoid focusing on daily price updates of any particular stock or other investments, especially moment to moment, Wendel said.

"That's just not healthy," he said. "It warps our decision-making process and it warps how we judge the value of something."