The Decision-Making Process: Rational or Not?

We all know that making rational decisions is key when it comes to saving for your future, but far too many investors allow their instincts to override their intelligence. These proclivities, known as behavioral biases, are irrational beliefs or behaviors that can unconsciously influence our decision-making process. Biases influence the ways we view the world, politics, our relationships, and even how we view our money.¹

In today’s rapid-fire, strobe light environment of quickly moving information it can be difficult to differentiate what is important and what is noise. The human brain, in its amazing efficiency, has created shortcuts to make sense of the world and make decisions quickly. Investors tend to rely on these shortcuts when it comes to making choices about their money.

Quiz

*See answers in "Outcomes" below.

You have a choice to make; either cut your losses and invest elsewhere or hold on to your shares. The danger in this bias is that future choices are dictated by fear of not making back money that is already invested. On the other hand, what should be assessed are future costs and benefits as part of their decision to hold or sell their shares.

Behavioral Bias

Sunk-cost fallacy, a term originally coined by Richard Thaler, is just one of over 100 cognitive biases that can unconsciously sway an investor towards a less than optimal decision.²

Sunk-cost behavior is irrational in that it leads to future decisions solely based on time, money, or efforts, regardless of whether the costs are recoverable or in our best interest.³ When making solid financial decisions, sunk-cost can present itself in a myriad of ways.

Examples

Think back to the times in your life that you may have made a choice that did not produce the best outcome, but you continued to spend time or money on that choice, regardless of whether the additional cost or effort would produce a better outcome. Some examples of this might include: 

• Finishing a boring movie, simply because you spent money on tickets, fountain sodas and popcorn at the theater
• Literally eating everything at an all-you-can-eat-buffet
• Over-spending at a casino in hopes of making your money back
• Staying in a bad relationship because you have invested time and effort.

* DILBERT © Scott Adams. Used By permission of ANDREWS MCMEEL SYNDICATION. All rights reserved.

Outcomes

What kind of investor do you identify with? Are you someone who would hold on to your 100 shares, despite having already assumed the loss? Or would you sell the shares and search for an investment that offers better prospects for the future? If you chose options “b” or “c” from the quiz, it is possible you are someone subject to the risks of sunk-cost bias. This kind of thinking can be detrimental to an investor and their savings because it can slow progress and yield undesirable results. Option “a” is the most rational of the choices in that it provides the most potential for success moving forward.

The advisors at Prudeo Partners understand the impact biases have on investors and the choices they make. We work with our clients so that they can make thoughtful and conscious decisions about how to put their money to work. Let Prudeo help you identify & navigate the behaviors that could be preventing you from achieving your goals. Learn more by visiting www.Prudeo.com.