Discover how confirmation bias influences financial decisions, leading to overspending and misguided investments, and learn strategies to avoid these common pitfalls for a more fulfilling life.
When you stop and picture a successful person, what comes to mind?
Your first thought might be someone with an impressive collection of material items; someone with a big house, an expensive car, and designer clothing. But if tangible, pricey items are truly what success boils down to, then why doesn’t money buy happiness?
True success is not defined by your outward image alone; it’s not a metric for what others think of you. What makes a successful life is something that only you can define for yourself. Success is also not a static finish line you can cross and feel permanently like you’ve “made it”. It’s an ongoing journey that requires persistent attention to your goals and brings a lasting feeling of personal fulfillment.
No matter how much money you have, or how much you’ve progressed in your career, or how many personal goals you’ve met, it may be hard to stop and “feel” successful, especially if the life you’re pursuing doesn’t necessarily meet societal definitions of success. Frankly, even if your achievements do match what success means to most people, it can still be difficult to feel like you’ve “made it."
When we feel detached from our accomplishments, we may seek to confirm our own image of success to ourselves and those around us by purchasing material items and cultivating a luxurious lifestyle. This can happen at every level of wealth. While there is nothing wrong with enjoying nice things, when we use material items as a proxy for fulfillment and a distraction from unmet needs, this becomes an issue.
Chasing a false idea of prosperity borne of others’ ideals is a form of confirmation bias that can obscure what you truly value in life and lead to irrational financial decision-making, leaving you with a void in both your heart and your wallet.
What is confirmation bias in finance, why are we so prone to it, and what can we do to make sure it doesn’t get in the way?
Confirmation bias is the human tendency to favor information that reaffirms our pre-existing beliefs and viewpoints, and subconsciously discredit anything we hear that contradicts these notions. This bias has wide-sweeping effects on many aspects of our lives, not the least of which is our finances. If you’ve ever observed anyone who seems to be stuck in their ways and refuses to try any new financial advice or strategies, confirmation bias is likely at play.
Staying deeply entrenched in one’s own beliefs with no room for nuance or contrasting thoughts stifles opportunities, causes irrational decision-making, and can keep someone from seeing a clear path to their goals.
Simply put, most of us are busy. We don’t always have the time or energy to question whether we’re making decisions based on a skewed perspective. When we have to make a choice and move forward quickly, we may lean on ideas we’re already familiar with, or follow behaviors we’ve seen lead to a positive outcome for others.
It’s in our nature to keep up with the Joneses. We’re social creatures who have historically survived based on following the pack, so the beliefs of those around us have the potential to sway our own perspective. Herding behavior can have a significant impact on our financial decision-making.
When our peers already have similar viewpoints to our own, they can reinforce and strengthen our beliefs, crowding out other schools of thought in our minds. And when we see repeated examples of others succeeding by, for example, following a certain financial strategy or investing in one industry over another, this can influence us to emulate that behavior and change our opinions to align with the group.
Heuristics are mental shortcuts that help us make decisions quickly and avoid decision fatigue. Studies approximate that we’re faced with an average of 35,000 decisions on a daily basis, so taking shortcuts helps us move forward with our day. While heuristics are helpful and even necessary for some decisions, they can also get in the way of rational decision-making. When we don’t take the time to think before we act, we can end up losing sight of the bigger picture.
Confirmation bias is one such shortcut. It allows us to make quicker decisions by filtering out information that doesn’t align with our beliefs. It also helps us feel confident in our understanding of the world, which helps us persist through the day. While confidence is important, there are also times when we need to leave room for other perspectives.
Confronting beliefs that contradict our own creates a sense of cognitive dissonance, which can be uncomfortable and even anxiety-inducing. Since our confidence relies on our ability to trust our own guidance, realizing we’re wrong can give us pause, negatively affect our self-worth, and even lead to decision paralysis. The fact of the matter is, though, nobody is right all the time, and pushing through the initial discomfort of acknowledging a contrasting opinion can help us be more well-rounded and rational in the long run.
Continuing to dodge uncomfortable truths, on the other hand, can leave you stuck in the wrong mindset and make decisions that you come to regret in retrospect. You may continue to stick to behaviors that don’t serve you while ignoring any evidence of their negative impact. For example, you may chase a career that you’ve been led to believe is the “right” choice for a successful person, even if there is strong evidence it’s not right for you personally. Picture someone who faints at the sight of blood trying to become a trauma surgeon, or someone who values family time above all else, choosing a position that forces them to travel 9 months out of the year. Yet the idea that the position intrinsically points to success keeps them stuck.
Confirmation bias can also reinforce or justify short-term impulsive decisions that provide immediate gratification. Even someone who’s generally frugal can occasionally fall prey to the allure of a little retail therapy. It can be easy to make a lofty, unneeded purchase based on evidence such as “this is a well-known brand” or “their products are high-quality,” while discounting the purchase’s effect on your wallet.
Confirmation bias can have a significant impact on your finances and life by hindering your ability to vet your decisions objectively. It doesn’t leave room for nuance or change in your daily decision-making, so your behaviors never evolve based on new information. This can keep you from moving towards the life you really want and making rational financial decisions. Our goals often change throughout our lives, but a biased mindset can lock us into a lifestyle that no longer aligns with our ideal life.
Here are just a few common ways confirmation bias shows up in people’s lives and finances.
This trend is seen most often among those who have experienced a meteoric rise to success, which, of course, tends to come with a windfall of cash as well. Professional athletes and musicians are the first examples that come to mind. They start making more money than most will ever see in their lives, and before too long, they’re buying Maseratis and mansions in Beverly Hills.
Why? Well, first and foremost, because they want to. But confirmation bias can be at play as well, especially once the initial thrill of fame passes. Since there are tons of examples of extravagant wealth in the news and in works of media, this has set a precedent for what success looks like for many people. This evidence can be used to justify purchases that contribute to an air of success.
Confirmation bias tends to keep you immersed in your comfort zone. People influenced by this bias may stick to hard and fast financial advice they’ve heard and ignore any signs that a different strategy may be better. For example, the adage “don’t go into debt” is frequently given by parents and mentors alike when someone is just starting out financially. If someone hears this from an early age, they may pay much more attention to stories about debt that have a negative turnout than anything they hear that reports a positive outcome.
While it’s a good idea to avoid any unnecessary or frivolous debt, especially high-interest credit card debt, there are some cases where, with a healthy dose of caution and much planning, debt can be beneficial in the long run. If your goal is to get an education or start a business, don’t let an adage alone stop you.
Investors are certainly not immune to confirmation bias. In fact, market trends are heavily influenced by investor sentiment. If investors believe that the market is heading one way or another, they may only absorb information that supports their belief.
This sometimes has a compounding effect; investor sentiment sways the market, then the market trends end up supporting and reinforcing the sentiment, causing the market trend to continue and further reinforce said sentiment. The news also often leans pessimistic, giving yet more credence to investors with glass-half-empty mindsets.
The dot-com bubble was possibly one of the most prominent recent examples of confirmation bias and herding. Both professional investors and those with personal portfolios were in a frenzy, pouring money into a booming sector that seemed too big to fail.
This bubble continued to grow despite some experts cautioning against “irrational exuberance”, until eventually it burst, leading many to lose thousands of dollars unexpectedly. Confirmation bias caused many investors to ignore any advice to not put all their eggs in one basket.
When we stick to our preconceived notions, we can’t grow and evolve, and our lives and finances stay stagnant. Remaining mentally in our comfort zones and relying on what we already know is more than understandable, as the pace of life can force us to choose a path quickly without much time to think. However, avoiding a change in mindset forever causes us to remain disconnected from what we truly want out of life.
Worse, our preconceived notions defining what a good life means are often influenced by what others think. So not only can confirmation bias cause us to stay stuck in our own past ideals, but these ideals may not have ever been ours in the first place.
There are times when being conservative with your finances is absolutely a good thing. However, there are also situations when taking risks can lead to a huge benefit. By remaining entrenched in your own beliefs, it can be difficult to see the benefit of taking certain risks or diversifying your portfolio, causing your gains to stall.
When you have an idea in your head about what success looks like, this can lead to irrational overspending. As I mentioned earlier, only you can define what success looks like for your particular life, but chasing a luxurious lifestyle in pursuit of an outward appearance of success can have drastic consequences.
Naturally, significantly overspending on unfulfilling items or ventures leads to a wallet full of moths, and can delay your ability to do what you truly want to do. Whether you’re trying to retire early, build a nest egg for your children, or start a business, losing money will throw a wrench in the works.
People may spend years building a life they don’t even truly want. Confirmation bias can cause this in two ways: either by influencing you to make decisions that don’t help you achieve your goals, or causing you to set the wrong goals in the first place.
I often see goals pulled in the wrong direction based on beliefs developed early on through a person’s mentor or education. Someone who is taught by a highly successful person, who chooses to showcase said success via a glamorous and expensive life, may think that they need to confirm their own success through the same type of lifestyle.
Then reality sets in. Maybe it turns out that the mentor was living beyond their own means, and their lifestyle was more of a sign of their ego than a representation of their success. Validating your own success with material possessions can be a trap. Not only will this fixation keep your attention away from what truly matters to you, but no amount of money spent will ever be enough.
This example is from my upcoming book “The Lobster League”, coming out soon. For more stories about the inseparable relationship between our finances and our goals, and how to remove barriers between you and your ideal life, be sure to pick up a copy.
It may sound strange, but the best way to contradict this bias involves both seeking out varying opinions and evaluating your own beliefs.
When thinking about your current life trajectory, it’s important to take the time to truly consider what you want out of life, regardless of what anyone else thinks. A strategy such as Rational Finance can be a big help here. However, seeking out varied perspectives from those around you, or by reading trustworthy studies or news articles that contradict what you already know, can help knock you out of a myopic or limited viewpoint. Others’ experiences can be a great source of guidance and inspiration, as long as their opinions don’t overshadow what you truly want.
It’s vital to find a balance between the perspectives of those around you, advice from experts, and your own wants, needs, and goals. If you know what you truly want, expert advice can help you get there, and others’ advice can guide you; just be sure to trust your instincts on subjects you’re familiar with, and don’t lose sight of your ideal life.
Success is relative, but we often struggle to define it for ourselves without being influenced by the opinions and expectations of others. Cognitive biases such as confirmation bias can keep us stuck in mindsets that don’t serve us and cloud the path to prosperity, leaving us chasing the wrong goals. It’s important to define what you truly want out of life, while leaving room for expert input where needed, as well as changes to your viewpoints that naturally occur over time. If you’re unsure how to align your goals with your finances, consulting an advisor, such as the team here at PFW Advisors, can help take some of the stress out of financial planning and help you feel confident in your financial future by refocusing your strategies on what really matters to you.
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