Last week, a dear friend shared an experience that made her sad. It made me sad, too – for my friend and the financial well-being of her now former client.
Here’s the backstory: My friend’s client had a revenue goal. But all of the suggestions offered by my friend, including asking her client to take a look at their pricing, was met with resistance. Even though raising their prices would have helped them reach their revenue goal, they refused. As they told my friend, “I don’t think the market would pay that.”
You might think the story I just shared is just about business and pricing.
I am sure some people get tired of me saying, “you don’t manage money, you manage your choices around money.” And, the reason I feel so convicted about this “idea in a statement” is because of how behavioral biases influence you and me.
Your biases color how you interpret and act on information, because you are not as rational as you’d like to think you are.
Three Out of Seven
There are about 100 cognitive biases in behavioral economics.
I’m going to highlight seven (7) that I believe you and I bump up against the most, with a particular spotlight on three* (3) that likely influenced my friend’s client and their resistance to listening to her recommendations.
Mental Accounting Bias
According to economist Richard Thaler, mental accounting is how you assign subjective value to your money. The found $100 is often used to prove this point; meaning: if you find $100, you’re likely to splurge and buy something you wouldn’t have if you had to work for that $100.
The presumption is that you think differently about money you didn’t earn, and you don’t think so carefully about how it’s spent. So, found money equals fun money, and earned money usually has a purpose assigned to it.
Can you remember when you’ve treated money differently based on how it “came” to you?
Loss Aversion Bias
Have you ever lost money on an investment? I have. And what’s worse, the darn stock hasn’t recovered since it took a hit in the 2008 financial crisis!!! However, I’ve yet to just sell it, take the loss (beyond paper), and replace it with another stock. (Funny side note: The initial brokerage firm has been acquired twice in the intervening years.)
Holding onto losing assets is one example of loss aversion bias.
Here’s another: Holding onto the status quo because it is what feels familiar and safe.
Loss aversion can cause you to focus only on what you might lose, and blind you to what you may gain á la the opportunity cost you may lose out on. So, you miss the chance to make the decision that seems riskier, but may in fact address larger, more complex problems. Thus, you potentially lose out on the chance to identify a more innovative solution.
This is one of the biases I believe my friend’s client was experiencing.
On the flip side of loss aversion is overconfidence bias. This occurs when you overestimate your abilities, skills, and knowledge.
It might show up as you believing you’re smarter on a topic than an expert on said topic. Or, you equate the quantity of information over the quality of it. Or, you underestimate how long it’ll take to complete a task or project.
When you find yourself not listening to feedback, it might be because you’re holding your abilities, skills, knowledge and beliefs in higher esteem than you do the facts of the situation.
Most of us have been overconfident at one point or another. I’m especially looking at all my fellow entrepreneurs and small business owners who, at times, let our optimism cause us to overshoot our sales estimates. 🙂
What makes this bias tough is that there’s a thin line between being too optimistic and being too confident. But it often becomes noticeable only after the line has been crossed.
So even if you admit it only to yourself, when was the last time you exhibited this bias?
You have goals, right? You’ve probably mapped out a specific plan for achieving them, too? If so, then you’re susceptible to experiencing anchoring bias.
This occurs when you’re unwilling to change your initial course of action – even though new information has become available that indicates you’d benefit from doing so.
Can you remember the last time you dug in your heels unwilling to budge on an opinion, or tweak your goal’s timeline, or modify your game-plan?
Almost everyone is familiar with the slang, FOMO. Sometimes, the fear of missing out will prompt you to do things simply because it is what everyone else is doing.
When it comes to money, I often see this behavior when individuals invest in stocks or mutual funds or venture capitalists chase start-up trends.
When it comes to business, I often see this when an entrepreneur or small business owner designs their business model and pricing after what others are doing. Without any thought of personalization.
This is another of the biases I believe my friend’s client was experiencing. They didn’t want to go left whilst everyone else went right.
“Past performance is not indicative of future results.”
You’ve heard this before, right?
It’s intended to help manage your expectations about outcomes. It’s also intended to encourage you to prioritize the process over the outcome.
Whether it regards how you save, invest, or earn money, where are you focused solely on the outcome and not paying attention to the process designed to create said outcome?
Sunken Cost Fallacy Bias
This is the third bias I believe my friend’s client was experiencing.
The sunken cost fallacy bias describes the tendency to follow through on a plan because of the time, money, and effort already invested. Even though there’s new evidence that proves the initial plan is no longer the best route.
As you prepare to do your mid-year review, is the sunken cost fallacy affecting any of the decisions you need to make?
The Lesson for Us All
The goal isn’t to eliminate your biases. I don’t even know if that is even possible – let alone feasible.
Rather, my point with sharing these biases is to help you recognize their existence in your life and business, and to encourage you to be honest about when they surface. Without shame or judgment.
This way, you get to choose if you:
Back to my friend’s now former client: Had she recognized the biases playing out for her she could have made choices that would have had a more positive impact on the well-being of her business, sales, revenue, and personal finances.
Instead, she made a choice to stick with the status quo. And at a pretty high price. It cost her the chance to:
- Earn more
- Work less
- Expand with whom she works (pricing your services or products to be accessible shouldn’t come at the expense of your own survival – #justsayin)
- Continue working with my friend who is amazing at what she does (The client could no longer afford my friend’s services.)
It’s not always easy to recognize or admit what biases are playing out. But, you give yourself the gift of making better decisions when you acknowledge them.
The Financial Wheel
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