The Cognitive Biases That Threaten Our Financial Prudence
Following an intense couple of months foraging the market for our next home, my husband and I have finally found the ‘one’. In reflection of our end to end house-hunting escapade, I’ve come to realise that whilst our ultimate decision was careful and considered, a whole host of sneaky biases threatened to dismantle the quality of our decision-making and thus, the shape of our bank account along the way.
The Endowment Effect
The endowment effect refers to the nature of individuals to overvalue, and therefore irrationally overprice, the items that they own. Homeowners commonly fall foul of this effect when placing their properties on the market. If the homeowner is lucky, an impulsive, unknowing customer may just wander along and snap up the property for it’s listed price. The homeowner profits profusely.
Don’t be that impulsive customer.
Large purchases demand careful deliberation. As a prospective buyer or tenant, you owe it to your bank account to acquire a robust understanding of the item of interest. For instance, though a property may seem ideal, how long has it been on the market? If it’s newly listed, chances are the owner hasn’t yet experienced a due reality check in the form of an absence of offers, and so the property remains overpriced. Thus, you have the upper-hand in the first round of negotiations.
On the other hand, perhaps the property has been on the market for a while and by the time it catches your attention, an offer deficit has forced the homeowner to price the property more fairly. In this scenario, whilst it’s natural to assume that you have less negotiating power, your inner sceptic should question why the property remains available. Either way, exercise caution and dig as deep into the details as you can.
The Recency Bias
Sort by: Newest first. The recency bias is our tendency to recall recent information and activity more clearly than what came before it. Naturally, it’s common practice for estate agents to take advantage of this common consumer bias, and save their best property viewings for last. For instance, on a day of multiple property viewings with an agent, you may find the first few viewings to be average, if not wholly unsuitable. Just as your doubt begins to kick in, the final viewing of the day meets your criteria and wows you. Like clockwork.
When we place the ethics of contriving a viewing facade to the side, this is generally a harmless agency tactic. However, it can become problematic in a few key scenarios; namely, if the last property viewed is out of your budget. In such a case, having ultimately been wowed, you’ll leave the agent on a high note and the recency effect means that you are much more likely to remember the expensive property that wowed you, rather than the previously viewed suitably-priced average properties with potential. This compromises your ability to be objective, paving the way for a suboptimal financial decision to follow.
The Mere Exposure Effect
Also known as the familiarity principle, the mere exposure effect is our tendency to favour that which we perceive as familiar. It’s a regular tendency to be risk-averse when we’re splashing the cash and we subsequently gravitate to a familiar safe space. For instance, when the time for a mobile upgrade arrives, holders of iPhones and Samsung devices are generally more inclined to stick with these established brands without a second thought, rather than explore less conventional options.
This premise takes many forms in the property landscape. For instance, many of us wouldn’t consider searching for a home outside of the areas that we know well. We say no to new turf, simply because it’s unfamiliar. Similarly, when we’re looking for an estate agency to assist us, we tend to favour well-renowned agencies over the lesser-known. Hence, the mere exposure effect can drive us to make relatively ignorant choices which can result in obscured decision-making.
The Loss Aversion Principle
Loss aversion marketing is rife. Think of all of the cheesy Limited Time Offer and Don’t Miss Out slogans we encounter on a regular basis. Despite its gross lack of subtlety, this style of marketing has proven itself to be an effective influence on consumer behaviour simply because it’s human nature to strive to avoid loss.
Therefore, when informed that another prospective buyer is interested in the same property as us, the notion of losing out invokes an irrational sense of urgency, likely prompting us to act in a hastier, less deliberate manner than we should when a considerable amount of money is at stake.
Similarly, when an agent tells us that a property is the last of its calibre expected to be on the market for a long while, we often cave into the pressure and act fast, rather than exercising prudence.
We can only overcome our cognitive biases once we’re aware of them. And what better time to enhance our self-awareness than in the current climate, where so few of us can afford to incur a financial loss of any sort. So whether you’re looking for a new place, a new car, or any other significant purchase for that matter, remember to check your biases, err on the side of caution and take full control of the decision-making process.
