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Money and Cognitive Bias

Bankrate.com has fantastic article entitled, "12 Hair-Raising Money Tales."  Some of the tales involve banker corruption, deceit ans so-called gotcha capitalism.  Many money mistakes involve decisions.  And thus there are problems with cognitive bias.  Take this example: 

In 1995, my husband's employer in Pensacola, Fla., sold to a company in Bowling Green, Ky. The economy was strong, and we were enjoying our Florida home and thinking about retirement. But my husband took a consulting position with the Kentucky company.

We took equity from our residence in Florida and bought a small home on a large lake in Kentucky. We planned to downsize, sell the Florida home and travel after my husband completed his work.

Isn't that typical?  That's optimism bias. "Optimism bias is the demonstrated systematic tendency for people to be over-optimistic about the outcome of planned actions. This includes over-estimating the likelihood of positive events and under-estimating the likelihood of negative events. It is one of several kinds of positive illusion to which people are generally susceptible."  

Someone gets a promotion: Don't just celebrate with a nice dinner.  Buy a new car!  A new house!  Spend right up to your new salary.  Live as if that new salary is always going to be there.

Let's put aside the spiritually-draining concept of supersizing one's spending.  If you're mostly happy with your current salary, why buy more stuff just because you have more money?  Your lifestyle was fine before your raise.  Plus, money is freedom.  Save enough money that you can tell your boss to go to Hell.  Watch your job-related stress fall.  Oh, you thought it was a coincidence that your boss always tells you to buy a house or to upgrade your car?    

I see optimism bias with friends my age.  Why are you in such a hurry to get into a house?  Besides the fact that owning a house makes one a debt slave: Why do you think you'll be able to keep paying the mortgage?  Is there a guarantee that the money will always be there?  Unless your parents are rich, what's your safety net?  No one needs a safety net, though.  Optimism bias.

Most people, though, underestimate the likelihood of negative outcomes.  It can't happen to me.  Yet another aspect of our culture of narcissism.