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THE PRIECE OF HASTY DECISIONS: a behavioral finance story

THE PRIECE OF HASTY DECISIONS: a behavioral finance story

SFClub Statale
February 24, 2025

THE PRIECE OF HASTY DECISIONS: a behavioral finance story

by Parviz Izadi

Our decisions are rarely as rational as we think. Hidden biases - confirmation bias, loss aversion, the sunk cost fallacy, and more - quietly influence our choices, specifically financial ones. We see it in investing, spending, and even everyday decisions. Let me take you through a day in my life that perfectly illustrates how these biases can play out in real time.

It is a cloudy day in November. I had been trading and ended up losing $76 on one share. This wasn’t part of my plan, but I followed an increase in buyers and jumped in, simply following the crowd. My analyzed shares are doing well, but my money is already stuck in that stock. Frustrated, I decide to let it go, take a break from trading, and head out for lunch.

At the Chinese restaurant, I can’t read the menu, but I spot “Chop Suey.” I order it because I’ve heard the name from a rock song with the same title. I don’t bother looking up pictures or translating the ingredients, I order purely based on past knowledge. When the plate arrives, I see chicken in it, which I don’t like at all. Since I have a $20 bonus for the restaurant, I leave $10 worth of food untouched and order something else.

Still trying to clear my head from the trading mistake, I call my girlfriend and talk about it. She invites me to a movie later in the evening to cheer me up and chooses the film. I pick her up from her house. She’s always complaining about my old 2006 Fiat and mentions knowing someone who would buy it at a decent price, but there’s no way that’s happening, my car is like my best friend, It has been everywhere with me and is worth far more than what they’re offering. I have chosen this car, and especially this Fiat, it is a special one, I refuse to sell it.

We arrive at the cinema, get our tickets, and settle in. Twenty minutes into the movie, we realize we don’t like it at all. It’s just another commercial comedy and not the mind-blowing film we had hoped for. We’re unsure what to do. She paid for the tickets, so leaving feels like wasting $16, but staying seems worse. In the end, we could have decided to leave, take a walk, and enjoy the cool early-night weather instead. At least we get home earlier. But instead, we chose to stay, unwilling to let the money go to waste.

On the way back, we see Black Friday advertisements on a billboard. Nike, Adidas, Ecco, and others are offering discounts of more than 50% for the upcoming week. But I don’t want to wait, I’m impatient. So, I decide I’ll just buy fake shoes the next day instead. I visit a shoe store nearby. As I enter, a large sign immediately catches my eye: “WAS $150, NOW ONLY $90!” The shoe is sleek and stylish, though it’s not a sneaker, it’s a pair of formal leather shoes. I hesitate because they’re not what I need, but the discount feels too good to pass up.

The original price of $150 keeps echoing in my mind, convincing me I’m getting an amazing deal, even though I wasn’t planning to buy formal shoes at all.

I convince myself that I’ll need them eventually, maybe for an event, a wedding, or even an interview, and decide to buy them instead of sneakers. On my way home, it hit me: I’ve spent $90 on a pair of shoes I didn’t need, and I still don’t have sneakers. My wardrobe dilemma remains unsolved, all because I couldn’t resist the allure of a great deal.

To consider psychological and financial factors, some decisions may be supported by logic, while others, due to a biased mindset, may not. It’s great to think like Elon Musk, aiming high and taking bold risks, but it’s equally important to behave like Richard Taller, making more thoughtful, rational decisions to ultimately succeed. How? This will be explored further as we examine the cognitive biases that influence decision-making.

Back to my story, remember my $76 loss in trading? That naive crowd all started buying, which made me step in even though I knew it was a mistake. I judged the trading decision harshly simply because it resulted in a loss, had it turned out profitable, what a smart move I had made! Even though the process of decision-making wasn’t sound. Taking a shortcut could end up leading nowhere, and, luckily, we arrive sooner at the destination. But is this described as a deadly mistake or a smart move?

Individuals are not always rational actors when it comes to financial choices. Instead, they may be influenced by biases, emotions, and social factors that impact their perceptions of risk, reward, and value, and this is the key premise of behavioral finance.

Behavioral finance

Behavioral finance is a subfield of behavioral economics. Our financial behaviors and choices are shaped by mental and psychological biases: on a personal level, these biases influence individual decision-making, while sudden rises or falls in the stock markets can also result from the biased decisions of market participants. In contrast to traditional finance, which assumes that individuals make rational decisions based on all available information, behavioral finance recognizes that people are often influenced by psychological factors, leading to predictable patterns of behavior. It combines principles of psychology with traditional economics to understand how human emotions and cognitive biases influence financial decision-making.

What matters the most for us is to stand at the point where psychology and personal finance meet, giving us insight into our financial decision base and how we can improve our decision-making processes. I will now show you some biases and, at the end, provide two general remedies to the whole phenomenon.

Common Biases in Financial Decision-Making

Confirmation Bias

Most don’t want to spend time and energy gathering information, let alone looking for useful ones. Confirmation bias is a cognitive shortcut our brain uses to make the process more efficient. I was sure about the trading crowd’s judgment because it seemed to align with my general belief that people collectively know what they’re doing.

Sunk Cost Fallacy

When trapped by the sunk cost fallacy, the impact of loss feels worse than the prospect of gain, so we keep making decisions based on past costs instead of future costs and benefits. It is a cognitive bias that makes you feel as if you should continue pouring money, time, or effort into a situation since you’ve already sunk so much into it. This perceived sunk cost makes it difficult to walk away from the situation since you don’t want to see your resources wasted. The cinema ticket case is one popular example.

Loss aversion

Is the tendency to avoid losses rather than pursue equivalent gains. Broadly speaking, people feel the pain from losses much more acutely than they feel pleasure from gains of the same size. Loss aversion bias typically shows up in financial decisions: people often need an extra - and sometimes significant - incentive to take financial risks that might result in a loss.

For instance, imagine a simple coin flip: if it lands on tails, you lose $10. Now, consider how much you would need to win on heads to make gambling feel worth it. Most people wouldn’t accept a mere $10 or even $15, they typically require a potential gain of at least $20 or more to take the risk. This demonstrates how losses feel more painful than equivalent gains feel rewarding. This classic experiment on loss aversion was conducted by Nobel Prize- winning economist Daniel Kahneman and his students.

Status quo bias

It is evident when people prefer things to stay the same by doing nothing or by sticking with a decision made previously (Samuelson & Zeckhauser, 1988). This may happen even when only small transition costs are involved, and the importance of the decision is great. Take my Fiat car, for example. Or think about when you want to upgrade your iPhone to a newer version. It wouldn’t cost much, yet some people still resist doing it. This is classic Status Quo Bias: holding on to what you know (or own), even when change could be easier and more beneficia.

The Anchoring Bias

is a cognitive bias that causes us to rely heavily on the first piece of information we are given about a topic. When we are setting plans or making estimates, we interpret newer information from the reference point of our anchor instead of seeing it objectively. This can distort our judgment and prevent us from updating our plans or predictions as much as we should. For example: “WAS $150, NOW ONLY $90!”, but how can I be sure it was really $150 before?

The Availability Heuristic (or Availability Bias)

refers to our tendency to give more credence to information that we are already aware of, particularly if that information is dramatic or emotionally charged. It skews our perception of reality, influencing our decisions based on the information most readily available to us rather than a balanced overview of all relevant data.

For example: I assumed the shoe prices in my neighborhood were the best because that's where I always shop, and I didn't even consider looking elsewhere.

Optimism bias

It is the tendency to overestimate the likelihood of positive events and underestimate the likelihood of negative events. It causes most people to expect that things will work out well, even if rationality suggests that problems are inevitable in life.
For example: A person takes out a large loan assuming they will easily get a promotion or a high-paying job to repay it, even though the job market is uncertain.

Common Biases in Financial Decision-Making

By understanding the cognitive biases that cloud our judgment, developing a healthy money mindset, managing our emotions, overcoming mental accounting biases, and recognizing the impact of social and cultural factors, we can make more informed and rational financial choices.

Before beginning the healing process, one must first recognize the inherent biases in the mind’s reasoning. After all, being aware that decisions could have taken different directions - or not been made at all - is of prior importance. Failing to recognize your own biases is itself a bias. This phrase highlights the very nature of unconscious thinking. Nobel Prize-winning physicist Richard Feynman noted, “The first principle is that you must not fool yourself, and you are the easiest person to fool”.

I know about my fears. Fears that cloud our financial decisions, creating doubts and causing panic. Fear can lead us to disinvest prematurely or avoid investing altogether, missing out on potential gains. I was greedy, greed caused me to take excessive risks or chase after hot investment trends without proper analysis.

Social norms, also peer pressure, played a significant role in my choices. Social influence - even from strangers in the market - made me buy that stock, or social exposure - pop culture, media, or common references - influenced my choice of ordering Chop Suey.

The discount tricked me into believing I was making a smart purchase, even though I didn’t need formal shoes. Society often encourages "smart shopping" based on discounts, making me feel like I’d be missing out if I didn’t buy them.

By developing awareness of our biases, we can make conscious efforts to mitigate their influence on our financial decisions. Am I prone to confirmation bias, anchoring bias, or perhaps a mix of them all? Awareness is the first step to overcoming these biases. By recognizing the impact of social norms and peer pressure, we can make more conscious and independent financial decisions.

To illustrate, overcoming the sunk cost fallacy requires resetting, reflecting, focusing on future costs and benefits, zooming out and in, embracing change, and, at last, acting. Change can be scary, but when it involves potentially improving your situation, you should be willing to at least try.

By acknowledging when a decision is no longer beneficial and adjusting accordingly, decision-makers can release sunk costs and focus on future possibilities for success. Accepting change in organizational behavior is necessary for making effective decisions and boosting resilience amidst constantly evolving conditions (Embrace change!).

If it’s hard to distinguish between tasks and priorities, try to zoom out a little, look at yourself from an outsider’s point of view, and then you will be able to spot the area for change (Zoom out!)

Now zoom in again and see that watching the movie till the end may justify the money that's already gone, but is it really worth spending even more time on it? Probably not. You can spend that time doing something else by the rules of opportunity cost: the most basic rule in the principles of Economics. (Zoom in!).

Once you’ve embraced change and shifted your perspective by zooming out and in, it’s time to take action (Acting!).

Here are two powerful ways to overcome biases and make better decisions

The 10-10-10 Rule: Simplify decision-making by evaluating choices across three timeframes:

10 Minutes: How will I feel about this decision right now?
10 Months: What impact will it have in the medium term?
10 Years: Will this decision still matter or benefit me in the long term?

This approach balances immediate emotions with long-term goals, ensuring clarity and purpose in your actions.

Keep a Decision Journal

Start keeping track of your decisions, document why you made a decision and revisit it later. Just take a moment to think, write down what you expect to happen, why you expect it to happen. No matter what happens in the world, we tend to look back on our decision-making process. A decision journal helps you collect accurate and honest feedback on what you were thinking at the time. Over time, patterns will emerge, revealing which biases affect you most frequently. By identifying these tendencies, you can refine your decision-making process and avoid repeating the same mistakes.

Using these tools together, you can take meaningful action, overcome behavioral biases, and make decisions aligned with your goals and values. Recognizing my biases was the first step. Now, with every decision - big or small - I pause, reflect, and ask myself whether my emotions or cognitive shortcuts are in control. The goal isn’t perfection, but progress toward making smarter, more intentional choices.

At the end of the day, our financial lives are shaped not just by numbers, but by psychology. The key to success isn’t about eliminating biases entirely, it’s about learning to recognize them and making choices with clarity, not impulse.

Sources

Credits

Author: Parviz Izadi - Editorial Area Associate
Editor: Alessandro Liberati - Editorial Area Manager
Graphics and layout: Simone Triozzi - Communication Manager