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Hello, MikedUp Blog readers! My name is Jerry, the creator of Peerless Money Mentor – a personal finance site that is primarily focused on helping people become financially woke, and I’m here to discuss how to not let cognitive biases delay your financial freedom.
First of all, I’d like to thank Mike for letting me borrow his digital space. I always find his content very entertaining and highly informative.
Today, I will talk about something we all struggle with: cognitive biases. While there are about 20 cognitive biases I can name off the top of my head, I have narrowed the list down to two. We will discuss the sunk-cost fallacy and recency bias.
I’ll tell a story of how I have struggled to overcome each one of these biases and provide examples. After covering each cognitive bias, I’ll provide a potential solution for mitigating the negative impact it may have on your life, so you can crush your goals and retire early.
Let’s begin by exploring what cognitive biases are.
(Title photo courtesy of Al Emmert)
What are Cognitive Biases?
Cognitive biases are basically errors in reasoning, due to imperfect knowledge and faulty memory. Every single human being on this planet is affected by these biases.
For example, have you ever invested more time and money into a project just because you spent years trying to make it successful?
Have you ever assumed some event would keep occurring in the future because it happened recently?
If you answered yes to both of these questions, then you have encountered the sunk-cost fallacy and recency bias before.
The Sunk-Cost Fallacy
According to the Cambridge Dictionary, the sunk-cost fallacy is “the idea that a company or organization is more likely to continue with a project if they have already invested a lot of money, time, or effort in it, even when continuing is not the best thing to do.”
For the sake of discussion, we will replace “company” or “organization”, with “individual”, since we are capable of making our own decisions in life.
I can remember a time period where I had a very difficult time overcoming this particular bias. It happened at the beginning of my journey from Broke to Financially Woke. Let me tell you the story of my ex-fiancee running away.
A Failed Engagement and its relation to the sunk-cost fallacy
I’ll never forget the day that I came home from work on my lunch break to see my ex-fiancée’s bags packed. She had decided that the relationship was not working out. It was time for her to move on, literally and figuratively.
To say I was shocked would be an understatement. The year before I had made the foolish decision to co-sign for her car loan. I thought to myself, “After all I have done for her, how could she just up and leave me so easily? We have been together for six years!”
It was a very painful breakup.
For the next couple of days, I could barely eat. One of my closest friends came to visit me, and I barely spoke; I was at a loss for words.
You’d think I would have moved on, right? I should have, but that’s not what happened. Instead of moving on, I decided to fight for our relationship. I put up a valiant effort and we eventually decided to do a long distance relationship for a couple months.
In the end, however, I ended up severing ties with her, effectively winning the battle against a bad case of sunk-cost fallacy.
You may not have had this experience, but I am sure you can relate to some more examples of sunk-cost fallacy.
Common Examples of Sunk-Cost Fallacy
Here are some common examples of sunk-cost fallacy:
- Deciding to continue watching a boring movie at the movie theater because you’ve paid for it
- Tripling your marketing efforts after a failed ad campaign you had become emotionally attached to
- Pouring more money into a business venture that has failed to generate a positive return for decades
So, now that you know what the sunk-cost fallacy is, how can you mitigate its potential negative impact on your financial life?
To minimize the negative impact of this bias, consider the upside of quitting a failed business venture or relationship. In one of my seven favorite podcasts, Freakonomics, I remember Dubner arguing that strategic quitting can be the best choice.
Think about some things that you could quit now that would improve your life. Could quitting your passion project be beneficial?
Now that we have explored the sunken-cost fallacy, let’s move on to discussing the recency bias.
According to the Skeptic’s dictionary, recency is “the tendency to think that trends and patterns we observe in the recent past will continue in the future.”
For example, if your financial life has been terrible in the past few years, you may think that it will never get better. As a result of this faulty logic, you project your financial misery into the future.
There was a dark time in my life when I did exactly that. It was a time when I wanted to set my two degrees on fire.
I wanted to Burn My Degrees
After graduating with two business degrees in 2009, I thought the world was mine. I’d soon land that high paying job that would put me on the fast track to achieving my financial goals. Employers would fight over me!
I wish that were the case. Instead of landing that high paying job, I struggled to find employment. I’d go on several interviews but hear back from only a couple companies.
At the time, there was a hiring freeze in the local government where I lived (Louisiana) but that did not stop me from applying to over 200 positions. I remember taking and passing several of the state exams.
While I got some interviews, no one hired me.
This is when I got extremely frustrated. My not-so-brilliant idea at the time was to create a site called “Burn My Degrees”. The plan was to create a video of me burning my degrees in an attempt to go viral. Then employers could finally see what they were missing out on.
Fortunately, I never created this site, because my friends (haters) talked me out of it. And I eventually found a job working in the mailroom of a print production company. While it wasn’t the job of my dreams, it sure beat unemployment.
That was a very dark time in my life; I was extremely pessimistic about my future.
Common Examples of Recency Bias
Here are some more examples of recency bias
- Refusing to invest in the stock market because you see the news that stocks have gone down lately
- Conversely, being overly optimistic about future stock market returns because we have been in a bull market
In life, there are a lot of unknown variables. Life often mirrors the stock market with its volatility. You have to take a deep breath and realize that – “this too shall pass”.
If you are facing a difficult time, sometimes it may help to remember a time in your life where you overcame adversity. Reach out to a friend or therapist if necessary.
Consider fine-tuning your strategy for success. You may be working hard but doing the wrong things. Don’t make the mistake of repeatedly doing the same things over and over and expecting a different result.
When it comes to investing, reaching out to a financial advisor may help you avoid making rash decisions during extremely good or bad times.
As human beings, we wrestle with cognitive biases on a daily basis. Imagine having to do a thorough cost/benefit analysis of every single decision we made. That would be burdensome, right?
Although we can’t eliminate these biases entirely, we can improve our decision-making skills by becoming aware of them.
When we improve our decision-making abilities, we make more rational decisions with our money. And hopefully, this will lead to us crushing our financial goals and achieving financial freedom sooner rather than later!
If you need any help overcoming any of these biases, I’d suggest speaking with someone who can point out the errors in your thinking. Seek professional help if you need it.
Best of luck to you on your journey! Thanks again Mike for letting me borrow your digital space.
What cognitive biases do you wrestle with on a daily basis and what do you do to overcome them?
Let us know in the comments below!
Thanks for reading!