3 Mistakes to Avoid in Personal Finance

The combination of loss aversion with mindless choosing implies that if an option is designated as the “default,” it will attract a large market share. Default options thus act as powerful nudges.”– Richard Thaler

Most of us want to avoid making financial mistakes when it comes to investing. Yet, we behave irrationally at times and commit some serious mistakes that cost us a huge financial loss. Interestingly, we don’t want to make such mistakes to begin with especially while taking some economic decisions. However, we are governed by our behavior which is different from Econs, who are perfectly rational fictional creatures and who tend to make economically wise choices. The term Econs was coined by behavioral economist Richard Thaler in his book “Nudge: Improving Decisions about Health, Wealth, and Happiness.” While it is not easy to become a financially literate robot, we can avoid making some mistakes. If you want to make wise financial choices, you must avoid making these three mistakes.

Present Bias

Most of the motivational speakers talk about living in present moment.  But, some people take this too literally and spend their entire money on making their present moment beautiful, without thinking about what the future will look like. Of course, it is good to stop worrying about your future, but it is not good to spend your entire funds on meeting your present day wants that you end up having nothing for future. In other words, one should not make such decisions that in future it is difficult to justify those actions and decisions.  Present bias is not always about instant gratification, it is making wrong decisions based on the present moment. For instance, after the financial crisis of 2008, many investors lost trust in real estate investing.  The decision to move the future investment based on your current market is what is termed as irrational by economists. So, avoid present bias as much as possible, because future is still a mystery and can be way different from your present moment.

Endowment Effect

This kind of bias or anomaly is very common in a real estate market. If the owner has a property up for sale, he or she will value it so high that buyer will not be interested, which may cause the owner to reduce the prices eventually.  The reason for such a high value in the first place is not the actual valuation of the property, but it is difficult for the seller to let go of that property. At this point, the seller is biased with the endowment effect which is also known as the status quo bias. Another example of such type of bias is when your favorite stock, which was once the darling of Wall Street, has surged and you want to hold on to that investment in the hope of avoiding losses. Well, this habit needs to change in order to get the money out of that sunken stock and be useful.

Optimism Bias

It is good to be optimistic and to think positive about life situation, but at times we tend to be over-optimistic and this tendency results into huge financial losses.  Suppose the property rates are going down, will it help to be optimistic and think positively? You got to secure your investments so that your future can be truly positive. You need to face the situation and cut your losses before it is too late.

The median person still thought that their prices were going to go up. That’s the definition of a bubble.”– Richard Thaler


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