Behavioral psychology and personal finance
This is the seventh article in our behavioral psychology series by Jonathan Walker, Co-Author of Anchors, Ostriches, and a HotPair of Scissors: Navigating Human Behavior as a Financial Professional. In this series Jonathan will help you understand how your brain deals with personal finances. Understanding these principles will help you manage your money and possibly avoid common but costly mistakes. Here is the full series:
- How to recruit your brain to help with better personal finances
- When being hot can hurt your personal finances
- How doing nothing can blow up your personal finances
- How to use mental accounting to improve your personal finances
- How too many choices can ruin your personal finances
- How anchoring can hurt your personal finances
- How an ostrich can destroy your personal finances
How an ostrich can destroy your personal finances
Poor ostriches. They get this bad rap about always sticking their heads in the sand when danger is approaching. Never mind that the cliche is wrong. The stereotype has stuck and so the flightless fowl continues to be the poster child (“poster bird?”) for willful ignorance in the face of uncomfortable information.
We can laugh at the birds for their unfortunate reputation, but behavioral psychologists have found that human beings often “stick their heads in the sand” when they have to face uncomfortable information. We do it all the time when it comes to our finances, too. And that can often make our finances worse, which make us want to avoid them more, which can make them worse, which can make us want…well, it’s hard to break out of the cycle.
What is the ostrich effect in behavioral psychology?
The ostrich effect, a principle in behavioral psychology, refers to our tendency to ignore negative financial information or risks, often by burying their heads in the sand like an ostrich.
When faced with unsettling financial news, we may prefer to remain ignorant rather than confront the situation. This can lead to delayed action, missed opportunities, or cause our financial problems to get worse.
The ostrich effect highlights the psychological desire to protect ourselves from negative emotions. We want to maintain a sense of security, even at the expense of long-term financial well-being.
How can the ostrich effect hurt my personal finances?
It probably isn’t too much of a surprise to understand how avoiding difficult information can ultimately cause a lot of problems to our finances. Problems don’t tend to go away on their own, no matter how much we choose to ignore them.
Here are some specific ways that the ostrich effect can hurt our personal finances:
Ignore financial problems
By succumbing to the ostrich effect, we may avoid confronting financial issues, such as mounting debt, overdue bills, or poor investment performance. Ignoring these problems only allows them to worsen over time, leading to more financial stress, missed payment deadlines, and accumulating penalties or interest.
Put off making important decisions
When we stick our heads in the sand, we might put off making difficult decisions on important financial matters. When we avoid seeking out financial advice, making investment decisions, or addressing a financial crisis, we can miss opportunities, get hit with late fees, or find a situation getting worse.
Fail to see a worsening situation
Ignoring financial problems can leave us vulnerable to the next problem that could come up. For example, neglecting to purchase insurance or adequately prepare for emergencies can expose us to significant financial losses if an unexpected event occurs.
Miss financial opportunities
The ostrich effect doesn’t always have to be about bad news. If we just don’t love to deal with our finances, even when they aren’t “bad,” we might miss important opportunities. We might fail to take advantage of an investment opportunity, neglect to negotiate for better terms, or ignore financial education. If we avoid complicated decisions because we can’t bring ourselves to deal with them, we could miss out on a better financial future.
Fail to plan for the future
By avoiding discussions about retirement savings, estate planning, or long-term financial goals, we may find ourselves unprepared for important life transitions or lacking a solid financial foundation. We might not love to talk about the future, especially if we are still dealing with a challenging present. We have to remember that the future will come whether we’ve ignored it or not.
Examples of the ostrich effect in personal finance
Here are a few examples of the ostrich effect in personal finances:
- Ignoring debt: You might avoid looking at your credit card statements, choosing to ignore the reality of your mounting debt. By burying your head in the sand, you only delay taking the necessary action to manage and pay off your debt. This could result in a worsening financial situation.
- Delaying retirement planning: By ignoring the need to save and invest for retirement, you risk facing financial challenges later in life when you are no longer able or willing to work.
- Avoiding investment decisions: You might choose to ignore investment opportunities due to uncertainty. By avoiding financial information, you could miss out on potential growth or fail to diversify their portfolio, which can impact long-term investment returns.
- Neglecting financial health checkups: You might avoid regular financial health checkups, such as reviewing your budget, assessing your savings progress, monitoring your spending, or evaluating your insurance coverage. By avoiding these assessments, you may not make the changes to your course that could help you avoid long-term problems.
- Ignoring financial advice: You might ignore financial advice from professionals. You might even resist seeking guidance, opting instead to rely on your own limited knowledge.
- Avoiding estate planning: You might avoid estate planning, including creating a will or establishing powers of attorney. Maybe the idea of dying feels too remote, too unlikely, or too uncomfortable. You might delay making important decisions about their assets and beneficiaries, leaving your loved ones vulnerable in the event of your unexpected passing.
How to keep the ostrich effect from ruining your personal finances
Sometimes the best way to avoid the ostrich effect is to “zip up your courage” and just get to it. But there are some things you might consider that can give you a bit of support so you don’t rely entirely on a strength of will that might be a little thin after the challenges of day-to-day living.
To overcome the negative impact of the ostrich effect on your personal finances, it’s important to:
- Be objective: Confront your financial situation honestly and objectively. If need be, tell your brain that you are looking at someone else’s finances. Find the emotional distance that will allow you to be a bit dispassionate about it. That will make it easier to face the situation.
- Make it easy to face reality: It’s hard enough to get up the courage to face an uncomfortable financial situation. Make doing so as easy as possible. Remove as much of the friction as you can: use banking apps, accept paperless statements, sign up for text notifications.
- Seek professional guidance: It could be that the situation is so difficult because you are out of your depth. There’s no shame in acknowledging that finances are complicated and you could use some professional assistance. Consult with financial advisors. Their expertise can help you make informed decisions and navigate complex financial situations. Even if you haven’t seen any of this before, they have.
- Find support: A spouse, a sibling, a friend, a parent, or an adult child can all be deputized to help you. Loved ones in your life want to see you succeed. They don’t need to be your enforcers, but be honest with them. Tell then that you have the tendency to stick your head in the sand and if they see you doing it, call you out.
- Develop a financial plan: When you do get up the courage to face everything, create a financial plan to deal with it. Facing it one month without setting up an actionable plan just means having to do all the work again. Set up a plan that will mean positive progress. That way you just have to monitor that you are staying on the plan.
- Learn the details: You might want to avoid situations because you don’t understand them or they feel overwhelming. Learning the details could go a long way to demystify the situation. Once you understand how it works, a lot of the “fear of the unknown” goes away. You can make more rational decisions about what you should do.
- Monitor your emotional reaction: Be aware of your emotional reaction. Recognize when you may be falling into the trap of the ostrich effect. Identifying when you are feeling that fight-or-flight reaction can help you put it aside. The ostrich effect is an emotional response. The emotional reaction can be controlled when you fully engage your rational brain.
By actively facing and addressing financial challenges, seeking professional advice, and planning for the future, you can minimize the harmful impact of the ostrich effect on your personal finances and work towards long-term financial well-being.