Humans are programmed to act in certain ways. We have behavioural biases built into us, created over the history of mankind, to keep us safe in the face of danger.

For example, we don’t like losing things. This is because our ancestors would be faced with a very nasty situation if they stumbled across a beast while out hunting, and realised that they had left their spear at home.

In today’s society, however, we are considerably less likely to be faced with a sabre-toothed tiger. Some of our behaviours don’t always act in our best interests, and some can even be taken advantage of by others. This is especially true around financial decisions.

Here, then, are three behaviours that we all exhibit to one degree or another, how they might not be serving us well, and what we might do about it.

The endowment effect

Researchers asked candidates to value a coffee mug. Half of those candidates were given the mug in advance, and half were not. The candidates who already owned the mug valued it around twice as highly as those who had not seen it before.

This is called the endowment effect. It describes how we tend to value something we already own more highly than its real worth.

There could be many reasons for this. Perhaps it holds sentimental value. Perhaps we overpaid in the first place, but we don’t want to admit it.

This also means that we often pay more for something than it is worth. Marketing and advertising take advantage of this. Take the trial period. At the end of that trial period, you are not only more likely to buy, but you are likely to be willing to pay more than you would before you had used the product.

Awareness is the enemy of the endowment effect. To stop ourselves from overpaying for something, or overvaluing stuff we already own, we should try and take a dispassionate and arm’s length view, and perhaps do some research on real valuations.

Framing

Framing describes a form of expectation.

An example of this is the 17-year-old daughter going to a party. She wants to be out until midnight, but knows that her parents wouldn’t normally allow this.

As she’s getting ready, her father asks: “What time will you be home?”

The daughter replies: “About 2 o’clock.”

“You will not, my girl,” says the father. “You’ll be back by midnight.”

Framing happens all the time with money. For example, when you visit a financial adviser, what are you expecting? Presumably, advice on your finances. And yet the adviser is just as interested in hearing about your plans for the future.

Framing is used in marketing all the time. It is why prices are so often stated as £9.99. Why is yoghurt 90% fat-free, not 10% fat? Once you understand framing, you will start to see it everywhere.

We can also positively use framing. Just a focus on strengths rather than weaknesses can result in making better financial decisions. This can make us feel more able to manage our finances and address some of those issues that we might have been avoiding.

Loss aversion

We feel the loss of something significantly more than its equivalent gain. Consequently, we try to avoid losses.

This is why the special offer with a limited time is used so much. Research from Which? suggests that most products on sale on Black Friday are actually cheaper at other times of the year.

Loss aversion is often applied to investments, whereby we might be less likely to invest if there is a risk of loss, even though the potential upside might be high. It can also lead to poor financial decisions as we try to avoid poor outcomes, which prevents potential positive outcomes.

Framing can actually help here. Taking some time to properly understand the potential loss (‘What’s the worst that can happen?’) can reframe the decision to fully take into account the upside.

Bonus tip: Avoid advertising

I go to great lengths to avoid adverts. When I go to the cinema, my family go in to watch the trailers and adverts. I sit outside.

Research has shown that advertising makes us unhappy. It presents unrealistic and unattainable images, then suggests that the only way we might achieve those versions of success is to buy that particular product.

Marketing and advertising are all around us, and they’re all designed to get us to spend money that we might not necessarily want to, or even able to afford to, spend. A little bit of work and knowledge to understand our behaviours and how to change our habits can make a big difference to our relationship with money.

Please note:

This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.