Submitted by nsscadmin on
The eighth part of our psychology of investing series takes a closer look at present bias. Do you ever make decision today at the expense of tomorrow? It could have been an impulsive purchase, snacking decision, or spending money that could have been earmarked for saving or investing. This could be present bias.
Present bias occurs when someone shows a preference towards short-term rewards over long-term rewards, even though in the long run, the long-term rewards may be much more valuable and beneficial.
Present bias can show up in everyday life in several different ways. Do you have a gym membership? Have you ever chosen not to go to the gym because you would rather watch TV or do some other activity that would give you immediate pleasure? That’s present bias, putting off exercise that could make you healthier in the long run for the quicker, easier pleasure fix.
One of the more common examples of present bias is procrastination. Putting off what you need to do until later to do something more enjoyable now. Of course, the moment of enjoyment may lead to stress later when you’re rushing to finish what you avoided doing by procrastinating.
How can present bias effect our financial and investing decisions? The most common financial implication of present bias is its effect on retirement savings and investing. The decision to save or invest money for future use goes completely against present bias, which influences you to spend and enjoy your money now. One of the biggest reasons people neglect or struggle to save for retirement or other future goals is present bias pushing them to spend today instead of saving for tomorrow.
If present bias has caused you to make poor investment decisions in the past or you believe you are susceptible to present bias, here are a few ways to protect yourself when investing.
Focus on your future self – One way to combat present bias and the immediate pleasure a financial decision may give you is to focus on and think about the long-term impact of financial decisions. What will the overall impact be of you buying that item instead of putting money into your retirement savings and investments? Is your long-term financial security worth risking for the short-term pleasure?
Automate your savings – The easiest way to save and invest a certain amount of money is to have it done automatically so you don’t need to think about it or force yourself to choose to do it. For example, many people will have a percentage of their paycheck automatically deposited into their TFSA or RRSP on payday. This money can’t be spent because it goes directly to savings, and it’s typically not missed thanks to the automation.
Rethink and possibly delay major purchases – If you’re considering a major purchase don’t let present bias and instant gratification force you into the decision to quickly. Take a break, think about the purchase and how it will impact your finances both today and long-term. Try to remove emotion from the decision and then determine if it’s the right call.
Our series on the psychology of investing continues in three weeks with Part 9 which looks at familiarity bias.