Sometimes our instincts lead us down the wrong path when it comes to money. We tend to focus on the negative, avoid risk and take a while to adjust to change. In behavioral economics, the mindsets that fog up our ability to maximize our wealth and reach financial goals are known as cognitive biases.
Understanding how these biases work is the first step in making sure we’re making informed decisions about our money. No matter what bias you’re dealing with, it always helps to take a step back, acknowledge your emotions and weigh the risks and rewards. This isn’t always as easy as it sounds, especially if you’ve never done it before.
Here are eight common money mindsets that could be holding you back from financial success, along with tips to counter these biases. If you still find yourself struggling to overcome them, consider working with a professional trained in spotting these biases with your best interests in mind, like a Certified Financial Planner.
1. You think you have greater control over your money than you actually do
Even if you’ve never worn lucky socks to a poker game or blown on dice before rolling, most of us think that we have more control over our money than we reasonably could. This is what behavioral psychologists call the illusion of control bias.
The illusion of control can lead to risky behaviors like problem gambling, but it also makes us assume that our proximity to an investment allows us to control the outcome. So, for example, we might invest in the company that we work for simply because we worked there, while avoiding investments that we have less of a personal connection to. Or we might feel overconfident about a stock we invested heavy time in researching without recognizing that the information — or our understanding of it — is ultimately incomplete.
Many of us act this way instinctually, so it’s not a bad idea to check your retirement accounts and other investments for signs of illusion of control. Look for investments that are concentrated in areas that you feel comfortable with. Better yet, get the opinion of a credentialed financial advisor, retirement specialist or other professional for objective strategies that can mitigate risk when growing your wealth.
2. You don’t always factor in inflation
Anyone who’s bought groceries in the past few years will tell you that a dollar today won’t get you anywhere near as far as it would have five years ago. But even in times of better-tamed inflation, you can expect your money to decrease in value over time. In fact, low-inflation times can be the most tricky, because it’s easy to forget that inflation is happening. And when you forget, you’ve fallen for what behavioral finance calls money illusion.
Money illusion is the mistaken assumption that a dollar this year will be worth the same as a dollar next year.
Say you put $1,000 in a savings account with a 1% APY in 2023. If you didn’t touch that money for a whole year, by 2024, you’d have $1,010. You might think, Oh, that’s great, I made money by doing nothing. But in reality, that $1,010 is worth only $981.06 in 2023 dollars. In other words, you actually lost money by letting it sit in a low-interest account.
You can get in front of money illusion by moving your cash to a high-yield savings account, certificate of deposit or money market account with an interest rate that’s higher than the current inflation rate. Investing in assets that typically appreciate over long periods of time, such as real estate or a diverse stock portfolio, can also offset losses to inflation. While investing your money in stocks, bonds, mutual funds, annuities and other assets offers higher returns than a high-yield bank account, they also come with more risk. But financial risk isn’t always a bad thing — especially when planning for the long term.
Expert tip: Inflation and your wages
With inflation on the rise, it’s a good idea to keep the money illusion in mind when thinking about wages. While many employers offer a pay increase every year, the amount you’re offered may not be enough to keep up with inflation. For example, when the annual inflation rate reached 8% in 2022, even the most generous estimates showed the average annual pay raise as lower than that rate. If you’ve been at a job for years without getting a promotion, you may find that you’re actually making less money now than when you started after factoring in inflation. If that’s the case, ask your employer for a raise to make up for this difference — or consider looking for another job.
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3. You focus on your losses
Ever notice that negative feedback sticks with you longer than praise? Unfortunately, humans are hardwired to give negative experiences more weight than positive ones — that includes financial experiences. If you’ve made a bad investment in the past or missed out on a lucrative opportunity, it’s tempting to let that deter you from doing something that feels similar, even when the circumstances are different. This is what behavioral psychologists call loss aversion.
Loss aversion is also what leads investors to hold on to underperforming investments longer than they’re useful, refusing to “cut their losses” and move on to a better prospect until they’ve recouped what they spent.
If you find yourself hesitating to do something with your money because of a previous experience, take a step back and try to focus on the circumstances you’re working with now, rather than staying stuck in what happened in the past. And stay realistic about your losses, accepting that even the best researched investments can be unpredictable. Some people also find it helpful to list out all of the positive financial decisions they’ve made as a reminder of what has worked in the past.
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4. You think you saw every curveball coming
We all know someone who thinks they knew it all along when something unexpected happens — the friend who swears they knew who would win the last election, the early crypto investor who’s convinced they knew Bitcoin would take off one day. In behavioral finance, this is called the hindsight bias.
Hindsight bias is the tendency to believe that you could’ve predicted something was going to happen before it did. This bias can result in trusting your instincts more than you should, potentially leading you to making rash or careless financial decisions. (It can also be the reason you beat yourself up or judge others harshly when something unfortunate happens.)
Memory is notably unreliable, so avoiding hindsight bias is often difficult. Some find it helpful to regularly keep notes about their financial decisions, which they can refer back to when they feel like they knew something was going to happen before it did.
It can also help to take a step back and break down any statements about hindsight. For example, if you find yourself saying “I knew that would happen” after a stock you just bought tanks, walk yourself through what that actually means. If you knew that would happen and you invested anyway, then you would have made a bad investment on purpose. Does that sound like something you would do? Probably not.
You might have thought it was a possibility, because it was. But it’s likely you also believed it could work out in your favor — enough for you to take that risk. If not, you may have been relying on another bias to guide your decision.
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5. You’re more afraid of losing than you’re excited to win
When I set up my first 401(k), I was terrified of investing. I couldn’t believe my company was making us gamble our retirement savings. So, I put all of my contributions into the safest portfolio available at the time, which was heavy on bonds. I knew these would give me lower returns but I couldn’t stand the idea that I might lose my retirement savings. I was experiencing what behavioral finance calls risk aversion.
Risk aversion is the tendency to choose safe financial options with low returns because we’re uncomfortable with the uncertainty involved in high-reward products. Often, we make risk-averse decisions because we aren’t familiar with how something works. For example, I was able to overcome my risk aversion by learning more about investments and personal finance. I eventually learned that even a high-risk portfolio often pays out over a long period of time as long as it’s properly diversified.
Over time, I slowly turned up the risk on my portfolio, and today I’m glad that I did. Hopefully I’ll retire with more wealth than I would have if I’d continued to play it safe.
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6. You’re slow to act on new information
Change is uncomfortable. When something dramatic happens that affects our finances, it can sometimes take a while to adjust to that new reality and react appropriately. When you hold on to a previous belief despite receiving credible, contradictory news, that’s called conservatism bias.
Say you buy shares in a company because it was well established. It had a track record of offering investors consistent returns, and experts seemed to agree that it was a safe choice. Everything goes well for a while until news breaks that the company is likely committing fraud. Even though you know that the company might go under, you hang on to your stocks longer than you should. After all, it’s been so reliable in the past. Eventually the company collapses, along with your investment. You were too slow to react.
One way to avoid conservatism bias is to stay on top of any new information and news relevant to your finances and investments, and take note of how you react. If a particular headline challenges you, take time to dive more deeply into its nuance. If you find yourself dismissing something that could potentially hurt your investments, ask yourself why — or seek out an unbiased professional for another perspective.
7. You silo your money — at all costs
Using separate accounts to save up for a goal can be a great way to keep tabs on your progress. But sometimes when we separate our money out like that, we can forget that we have access to those funds when we’re stuck with a surprise bill. If you’ve gone into high-interest credit card debt or took out a personal loan to pay for something when you had the cash, you’re doing something behavioral finance calls mental accounting.
Say you wanted to save up for the down payment on a house and set up a dedicated high-yield savings account that you contribute to every month. A few years in, your car breaks down and you can no longer get around. Rather than using some of that down payment money, you decide to put the repairs on your credit card. It takes several months to pay it off, partly because you’re paying a 25% APR. The extra interest charges end up costing you hundreds of dollars in payments — unnecessarily delaying your goal of home ownership.
To avoid mental accounting, use cash for large purchases whenever possible — even if it means tapping into a special savings account. Also, try to avoid spending money just because it’s available. Instead, take a holistic approach when budgeting and managing your assets to make sure that your wealth is being put to work appropriately.
8. You use the first price you see as a benchmark
Just the other day, I was shopping around for a new desk and was shocked to see how expensive they were. The first one I came across was $4,000, which seemed like way too much money. I didn’t buy it, but knowing that a desk could get that expensive sure made a $300 desk sound reasonable. I was feeling the effects of an anchoring bias.
Anchoring is when we mentally latch on to the first information we get about something and compare it to things that are similar. Companies often take advantage of anchoring to get customers to feel comfortable with paying more money than they’d planned. For example, restaurants sometimes list the most expensive item on the menu first to make their $25 grilled cheese feel like a good deal.
This can also work in reverse. If the restaurant in our previous example had reordered the menu, we might balk at the price of that $25 grilled cheese. We’re forgetting that restaurants have extremely tight margins, and if it pays its staff a living wage, $25 might actually be a fair price. But we’re used to paying $5 for a sandwich, so it feels like a bad deal — even though it isn’t.
Realistically, it’s difficult to avoid anchoring all of the time — that would require a lot of research. But before you make a big purchase or decision that affects your finances, do some planning and research your options. It can help to come up with a price, interest rate or monthly cost that you’re comfortable paying, depending on the product. This can help you make an informed decision, comparing your options more rationally against your target points. In some cases, you might find that the true cost of a product or service is too much for your budget, and that’s when you can turn your attention to alternatives.
Tips to counter your negative money mindsets
This list of biases is by no means exhaustive, but you can use similar strategies to counter most negative money biases. Because it’s not always easy to notice we’re making a biased decision, it’s always helpful to go back on the facts. This is particularly true when you find yourself having a strong emotional response to a financial decision. When this happens, take a step back and weigh the risks, rewards and alternatives.
Monitoring your finances as a whole, rather than focusing on one specific part of your finances can also help you avoid making biased mistakes. This can help you see how your decisions affect your total wealth and find weak spots that you might have missed otherwise. For example, it’s a lot easier to be aware that you have too much credit card debt than it is to realize you don’t have enough retirement savings, even though both are important to financial wellness.
When you’re not sure where to start or feel overwhelmed, you always have the option of talking to a professional — be it your accountant or a financial advisor. Make sure they’re credentialed or have positive reviews from trusted sources before you take anyone’s advice to heart.
FAQs: Money mindsets, savings tips and growing your wealth
Learn more about how to save wisely, including smart tips to overcome negative money mindsets. And take a look at our growing library of personal finance guides that can help you save money, earn money and grow your wealth.
I’m worried about outliving my retirement savings. What are some tips to make it last longer?
As you approach retirement, one of the most critical decisions you’ll face is how to strategically withdraw from your hard-earned savings. The order in which you tap into your various retirement accounts can significantly impact your tax burden and the longevity of your nest egg funds. While there’s no one-size-fits-all withdrawal order, learn general rules of thumb in our guide to a retirement withdrawal strategy.
Can dollar-cost investing be a useful tool to counter a biased money mindset?
It could be. Dollar-cost averaging is an investment approach that takes the guesswork out of when to invest your money. Instead of trying to time the perfect moment to invest a large sum — a form of the illusion of control bias — you invest smaller amounts regularly, like clockwork, regardless of market conditions. For example, investing $1,000 monthly over a year rather than $12,000 all at once helps protect you from putting all your money in when prices are high. Learn more about this structured way to grow your money — whether you’re a new or experienced investor — in our comprehensive guide to dollar-cost averaging.
Can a money mindset make you vulnerable to scams?
Yes. Many scammers use manipulation tactics to prey on negative money mindsets like conservatism bias and loss aversion — even the fear of missing out — in an attempt to exploit your emotions and part you with your money. Fraudsters aren’t afraid to put in the time needed to build trust, keep you engaged and raise fear that you’re not acting fast enough, depending on the scam. Learn more about the top financial scams to watch for, including how to keep your money safe.
Is a financial advisor worth it for retirement planning?
Yes, for most people. A financial advisor can help you manage your money as you plan for retirement, while giving you a sense of how much you can spend during retirement to make your savings last. Their financial advice and market expertise may also help maximize your savings. If you’re anxious about retirement, working with an advisor can also give you peace of mind by assuring you that you’re on the right path. Start with our guide to finding a trusted retirement advisor.
About the writer
Anna Serio-Ali is a trusted lending expert who specializes in consumer and business financing. A former certified commercial loan officer, Anna’s written and edited more than a thousand articles to help Americans strengthen their financial literacy. Her expertise and analysis on personal, student, business and car loans has been featured in Business Insider, CNBC, Nasdaq and ValueWalk, among other publications, and she earned an Expert Contributor in Finance badge from review site Best Company in 2020.
Article edited by Kelly Suzan Waggoner
