The human brain often leans on biases and shortcuts, which gets in the way of rational financial decisions. Learn how to overcome cognitive bias in finance.
When we think about our finances, we focus on key numbers, including income, expenses, savings, and investments. Something many people fail to realize, however, is that financial health is about mindset just as much as it is about math. Your fears, hopes, habits, and blind spots can have just as much of an impact on your wealth as your income, assets, or budget. That’s why even people with a high level of financial literacy can struggle with wealth management — our minds can get in the way.
Cognitive and emotional biases can distort how we see our financial situation and cause us to make decisions that don’t actually align with what we want out of life. When we begin to understand these biases and how to work around them, we can start building a financial future that truly fits our goals.
Financial health is a snapshot of how stable, flexible, and future-ready your finances are. Common benchmarks include:
The specifics of being financially healthy aren’t one-size-fits-all, and it can look different for each person.
Defining your long-term goals is the first step to assessing your current financial health. When you think about what you want out of life, what’s the first thing that comes to mind? Buying a home, traveling the world, supporting your family, or simply feeling less stressed?
Your goals may start out nonspecific, but once you have the basics down it’s important to narrow down exactly what they mean to you. Many times, when people are thinking about their vision for their ideal life, they may find they have emotionally charged yet vague goals such as “freedom”. While freedom is a great goal, the meaning is different for everyone. Freedom may mean having enough money or sources of income to take the pressure of requiring income from work, or it could be to achieve something specific like taking a year off to travel the world.
Once you know what your goals are, you can measure your financial health by how well your current habits and decisions are supporting your ideal life.
Here’s the hard truth: our brains aren’t naturally built for financial decision-making.
The human brain can make 30-35,000 decisions a day, but to handle this volume of thoughts and decisions, our brains need to take shortcuts. We’re naturally wired for quick thinking and impulsive, emotional reactions, which are key for survival, but they don’t always serve us well when navigating the modern financial landscape.
We all have some degree of cognitive biases, both inherent to human psychology and developed through life experiences. These biases influence how we interpret information, what we prioritize, and what we avoid. They also lead us to not make rational financial decisions.
Confirmation bias: We seek out or give more weight to information that supports what we already believe. For example, if you’re convinced the stock market is too risky, you might ignore data that shows long-term growth.
Cognitive dissonance: We may act in a way that contradicts our beliefs, or hold contradicting beliefs simultaneously. This can lead to discomfort and avoidance, or getting defensive and doubling down, causing us to make irrational decisions. For example, you may know saving is important, but if you’re spending beyond your means, you might find ways to justify it instead of confronting the mismatch.
Endowment effect: We may overvalue something just because we already own it. A key factor in the endowment effect is loss aversion, which means that people experience losses more intensely than equivalent gains. Essentially, ownership creates a sense of attachment and perceived value that goes beyond the item's objective worth. For example, you might price a piece of jewelry or a car you own higher than its market value because you've attached sentimental value to it through ownership.
Because many of these behaviors are subconscious or automatic, you might not even realize they’re happening. These biases create blind spots, making it harder to recognize financial risks, opportunities, or misalignments with your long-term goals. They often cause us to make decisions without thinking through the situation first. Impulsive or poorly thought out decisions hurt your financial growth by making you hesitate to take risks, telling you to put money into the wrong investments, and making decisions that are out of alignment with what you want to achieve.
Heuristics are the mental shortcuts we use to simplify complex decisions. When we can’t consider all the information about a decision we need to make, we’ll utilize knowledge we’ve gained from past experiences and our understanding of the world. Heuristics help us to make quick decisions without cognitive overload.
While useful in everyday life, they can be risky when it comes to finance. Similar to cognitive biases, they prevent you from seeing the whole picture. Heuristics can cause us to act on incomplete information, stay stuck in the status quo, or make fear-based decisions that sabotage progress.
For example, the availability heuristic is that we make decisions based on the first information that comes to our minds. If the first thing that comes to mind when you think about investing is Black Tuesday, it might disproportionately influence your decision to invest in stocks, even though it happened nearly 100 years ago.
Here is an example that applies to our financial health: When we’re in the process of setting a goal like achieving financial freedom and are considering what that means and how to achieve it, our brains tend to lean on shortcuts. We may only take into account the things we know we need to plan for in the near future, and what freedom means to us currently. Many times, expenses related to prospective events in the far future won’t come to mind. Maybe you want to pay for your child’s wedding down the line, but your child is nowhere near marriage at the moment. When you’re thinking about the amount of money you need to achieve financial freedom, this expense may not be factored in. People tend to forget about many types of future expenses, such as long-term care costs they may incur later in life.
Once you’re aware of how your brain works when it comes to finance, you can outsmart your biases and override your heuristics. That’s where Rational Finance comes in.
Developed by PFW Advisors Founder Scott Mackenzie, Rational Finance is a framework designed to help people make financial decisions that reflect their true desires rather than subconscious biases, fears, or habits. Rational Finance is about making money decisions with clarity and intention. It starts with getting specific about what you want from your life and then using that vision to guide your choices.
This means:
And you don’t have to do it alone. Working with a holistic financial advisor who understands both the technical side of finance and the emotional, human side of decision-making can help you move forward with more confidence. A good advisor will challenge your blind spots, help you spot your own biases, and keep your goals in clear focus, even when your emotions try to cloud them. At PFW Advisors, we use Rational Finance to help you stop reacting and start mindfully planning.
If you’re ready to take a more intentional approach to your finances, start by defining your vision and working with someone who can help you stay on track when your brain tries to pull you off course. When you understand how your brain may be getting in the way, you can start making smarter, more strategic decisions. After all, financial health is as much about mindset as it is about money.
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