How Projection Bias Could Be Destroying Your Finances

By Emily Guy Birken on 18 October 2018 0 comments

Have you ever gone grocery shopping on an empty stomach? If you’re like most people, you come home with all kinds of random junk food and disparate ingredients you have no specific plans to use, all because they looked good at the time.

So when you decide to throw some “lightly expired” shrimp, Lonely Gal Margarita Mix for One, and an entire shelf’s worth of tortilla chips into your cart when you only needed a gallon of milk, you are falling victim to a cognitive bias known as the projection bias.

This bias causes you to believe that however you are feeling in the moment is how you will still feel in the future. So when you are feeling rumbly in your tummy while cruising the grocery store, you believe you’ll still want to eat shrimp-covered nachos once you get home — even though your enthusiasm for shrimp that’s gone to the bad place will definitely wane once you’ve had a snack.

Of course, the projection bias does more than just fill your grocery carts with food you’ll never eat. It can also cause you to make even bigger financial mistakes. Here’s how your inability to project your future preferences can ruin your finances. (See also: 5 Mental Biases That Are Keeping You Poor)

Irrational shopping

Car dealerships have long found that they sell more convertibles in the spring and summer than in the winter. Some of that is perfectly natural. A car buyer is likely to want to purchase a car whose amenities they can take advantage of right away. But convertible sales also spike during sunny days or warm spells during the winter. In those cases, the irrational convertible owner is projecting that she will want to ride with the top down and the wind in her hair every day, just because that’s what she wants on the unseasonably warm and beautiful day when she buys her new car.

Similarly, when you are in the midst of a new enthusiasm for exercise, it might seem like a great idea to buy a treadmill or elliptical machine. You want to exercise every day right now, so of course you’ll want to continue exercising in the future. There is no possible way that your new BowFlex will collect dust and/or become an impromptu clothes-drying rack within a few weeks of purchase.

One of the best ways of thwarting this expensive projection bias mistake is forcing yourself to take a cooling-off period before making any major purchases. Test driving the convertible BMW may be a blast on that random 70-degree day in late February, but will actually purchasing the car still feel as reasonable a week later when the snow is falling? Forcing yourself to wait a week (or a month) before making any large purchases can help you keep projection bias at bay. (See also: 9 Simple Ways to Stop Impulse Buying)

Not saving enough

The closest I have ever come to slapping someone was when a teaching colleague once told me that she didn’t bother saving money for retirement because she wanted to enjoy her money while she was young. This colleague seemed to believe that she would always enjoy good health and stable employment, and that she could just continue to work forever.

This kind of thinking is a common symptom of projection bias. We all tend to assume that the way our lives are now are how they will continue to be in the future. So we don’t bother to save money for a rainy day or for retirement, because we project today’s stability into the future.

This is one of the reasons why pessimists tend to be better savers than optimists. Pessimists expect things to go wrong, and they plan accordingly. So it’s a good idea to embrace your financial pessimism and think through all the potential ways Murphy’s law could throw a wrench in your life. You’ll be less likely to assume that your current life will remain unchanged forever — and you’ll be more likely to save money to protect yourself. (See also: 4 Ways Pessimism Can Actually Improve Your Finances)

Locking up money in illiquid investments

Whether you're investing in real estate or buying an annuity, the projection bias can potentially prompt you to make an expensive mistake. That’s because you might decide to put your nest egg into a real estate venture or annuity product when you're doing well financially. If your job feels secure and you can’t imagine needing to tap into your nest egg, it can feel foolish not to invest in something that will grow over time or provide you with guaranteed retirement income.

But job loss can strike anyone at any time, and if all of your investment money is tied up in a rental property that you cannot sell or an annuity that you cannot get out of, then you'll be stuck making some pretty difficult financial decisions until you are able to find another job.

While putting your money in illiquid investments can be a savvy financial move for the right investor, it’s important to think through what would happen if you were to lose your job or experience a financial downturn. When you consider making such investments, be sure you also have a Plan B for if life does not continue in the same way. (See also: How to Get Your Finances Back on Track After Losing Everything)

Buying a timeshare or retirement condo

One of the big problems with the projection bias is the fact that marketers and salespeople (not to mention con artists) are all perfectly aware of how this mental quirk works. So they make absolutely sure you have a great time with whatever they are selling to help you project future good times if you buy their product.

Two industries that often rely on this bias are timeshares and retirement condos. In many cases, both of these types of purchases require an upfront payment for future residence. While it’s possible that you will still want to visit Florida the first week of August every year in perpetuity, or that you will want to move into the 55+ condo community after you retire, you may also change your mind and feel stuck with an expensive choice that you may have trouble getting out of.

These types of purchases should also only be made after a great deal of thought, rather than right after a fun-filled weekend visit. (See also: Are Timeshares Ever Worth the Investment?)

The future will be different

The trick to keeping projection bias from destroying your finances is remembering that the future will not be exactly like the present. So it pays to be flexible in your plans for the future, and a little pessimistic about what you can expect.

Even if there are nothing but blue skies ahead and your tastes never change, you’ll still be glad you kept your finances flexible (and robust).

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