Here's what you need to know about present bias and how it can impact your account balances, debt and more.
If I offered you five dollars today or ten dollars in a week, which would you choose? A recent study by Morningstar examined the effect of behavioral finance biases on investment decision-making and found that those who chose a financial reward closer to the present saw a 0.26% fall in their total savings account while making an investment decision.
Present bias is one of the many cognitive biases in behavioral finance, and is defined as the tendency to overvalue smaller rewards in the present at the expense of long-term goals. In Morningstar’s study of investor behavior, it was found that as a person’s present bias increases, so do the odds of having higher debt — by 1.19 times.
It’s easy to pick the immediate gratification, whether that’s splurging on a shopping trip instead of saving that money for a car, or impulsively buying a stock option that is performing well right now but may not pay off in the long run.
The best way to ensure your financial health is limiting the possibilities of financial biases. Check out our top three tips on how to overcome behavioral biases when it comes to your finances.
Three Ways to Overcome Present Bias
Map Your Goals
What are your financial goals? Saving for a down payment on a house, a car? Knowing what you want can be the easy part, planning how to get there takes a bit of work.
Once you’ve identified your financial goal, start creating a road map of how you plan to get there. Start tracking expenses, and plan how much you want to save each month with a set time frame.
Think Twice Before You Buy
It’s easy to make impulse purchases, especially when you want it now. Before you swipe your card, think to yourself, does this impact my financial goal? Will this purchase still serve a purpose in 3 months? If the answer is yes to the first question or no to the second, it’s probably smartest to put your card back in your wallet.
Pay Yourself First
Use automated banking to your advantage by setting up an automatic transfer to your savings account. This way, it’s already moved before you can think about it, and you’re committed to your set amount each month.
There are many things in life that are out of our control, but what matters most is what we do with what we can control. Being conscious of our possible biases is one way of combatting them. Connect with your Farm Bureau agent today to review your current investment plan, or review our other investment options today to get started.