Why Your Brain Is Sabotaging Your Wealth
The Money Mistakes That Feel Smart
Your brain is trying to keep you poor.
Not intentionally, of course. Your brain was designed to help you survive in a world of scarcity, immediate threats, and small tribal groups. It's incredibly good at keeping you alive. Unfortunately, the same mental shortcuts that helped your ancestors avoid being eaten by lions are now causing you to make terrible financial decisions.
These mental shortcuts are called cognitive biases, and they cost you money every single day. You're not making bad financial decisions because you're stupid or lazy. You're making them because your brain is operating exactly as designed, for a world that no longer exists.
Today we're going to examine the specific cognitive biases that are sabotaging your wealth. I'll explain how each one works, why your brain does it, and most importantly, how to overcome it so you can build wealth despite your brain's best efforts to stop you.
Understanding these biases won't just save you money, it will help you understand why smart people (including yourself) make predictably dumb financial decisions.
Note: I enjoy reading about psychology. Most of my learnings in this area were from reading Thinking, Fast and Slow, a 2011 classic from Daniel Kahneman. It’s not an easy read, but you’ll learn so much about your brain!
I created a list of eight common biases. There are others, but hopefully after reading about these, you’ll be convinced they are real and know how to watch out for them.
Why Our Brains Aren't Wired for Money
Before we dive into specific biases, it's important to understand why this happens.
The historical mismatch: Your brain is well-suited to handle immediate, physical threats in small groups. Money, investing, and long-term financial planning have only existed for a few thousand years, a blink of an eye in historical terms.
Fast vs. slow thinking: Your brain has two systems. System 1 is fast, automatic, and emotional. System 2 is slow, deliberate, and logical. Most financial decisions happen in System 1, which is terrible at math and long-term thinking.
Scarcity mindset: Your ancestors lived in a world where food was scarce and winter was deadly. Your brain is wired to prioritize immediate rewards over future benefits, which made sense when tomorrow wasn't guaranteed.
The good news: Once you understand how these biases work, you can design systems to work around them. You don't need to overcome your biases. You just need to recognize them and plan accordingly.
Anchoring Bias: Why the First Number Ruins Everything
What It Is
Anchoring bias is your brain's tendency to rely too heavily on the first piece of information you receive. That first number becomes an "anchor" that influences all subsequent decisions, even when it's completely irrelevant.
How Your Brain Does This
When you encounter uncertainty, your brain looks for any available reference point to guide decisions. The first number you hear becomes that reference point, and you unconsciously adjust from there rather than thinking independently.
Real-World Money Examples
Car shopping: You walk onto a lot and see a truck with an MSRP of $55,000 marked down to $40,000. You think you're getting a great deal, but similar trucks sell for $35,000 elsewhere. The $55,000 MSRP anchored your perception of value.
Salary negotiations: Your boss offers you a $50,000 starting salary. You negotiate up to $55,000 and feel good about the "win." But if you'd researched first and learned the market rate was $65,000, you would have anchored much higher.
House hunting: You see a house listed for $450,000. Even if you offer $425,000 and get it accepted, you're still anchored to that listing price. You never considered that the house might only be worth $400,000.
Investment decisions: You bought a stock at $100 per share. It's now worth $60, but you refuse to sell because you're anchored to that $100 purchase price. Meanwhile, if you were buying the stock fresh today, you'd never pay $60 for it.
The Actual Cost
Anchoring bias costs the average person thousands annually:
Car purchases: $2,000-5,000 overpaid
Salary negotiations: $3,000-10,000 annually in lost income
House purchases: $10,000-30,000 overpaid
Investment decisions: Holding losers too long costs 2-3% in annual returns
How to Overcome It
Do your research first: Know the market value before you see any prices. Look up Kelley Blue Book values before car shopping. Research salary ranges before job interviews.
Set your own anchors: Decide what you're willing to pay before you see asking prices. Write it down to make it concrete.
Get multiple data points: Don't let one number dominate your thinking. Look at comparable sales, competitive quotes, and market ranges.
Sleep on big decisions: Your initial anchor loses power over time. Wait 24-48 hours before making major purchases.
Confirmation Bias: Why You Only Hear What You Want to Hear
What It Is
Confirmation bias is your brain's tendency to seek out, interpret, and remember information that confirms what you already believe while ignoring contradictory evidence.
How Your Brain Does This
Your brain treats contradictory information as a threat. It's easier and more comfortable to process information that supports your existing beliefs than to challenge them. This helped our ancestors maintain group cohesion, but it hurts modern financial decision-making.
Real-World Money Examples
Stock picking: You bought shares of Tesla because you believe in electric vehicles. You read every positive article about Tesla and Elon Musk while ignoring concerns about valuation, competition, or production issues. You're not getting the full picture.
Investment strategy: You believe real estate is the best investment, so you only read real estate investing blogs and talk to other real estate investors. You ignore studies showing index funds have outperformed real estate over the long-term. (Leverage can change this conclusion, but you can also lever stock investments with margin.)
Financial advisors: You choose an advisor who tells you what you want to hear ("Yes, you can retire at 50 with a 20% savings rate") instead of one who challenges your assumptions.
Budgeting: You believe your spending is reasonable, so you focus on the months where you stayed on budget while dismissing the months where you overspent as "exceptions."
The Actual Cost
Confirmation bias leads to:
Poor investment diversification (concentrated positions)
Holding losing investments too long
Missing opportunities that don't fit your preconceptions
Following ineffective financial strategies for years
Studies show investors who exhibit strong confirmation bias underperform the market by 2-3% annually due to poor decision-making. (source)
How to Overcome It
Actively seek contradictory information: For every positive article you read about an investment, read a negative one. Force yourself to consider the opposite viewpoint.
Use devil's advocate thinking: Before making a financial decision, spend 10 minutes trying to argue against it. What could go wrong? What are you missing?
Track your predictions: Write down your financial predictions and check them later. When you're wrong, figure out what information you ignored.
Get outside perspectives: Talk to people who disagree with your financial strategy. They'll point out blind spots you can't see.
Overconfidence Bias: Why You Think You're Better Than You Are
What It Is
Overconfidence bias is your brain's tendency to overestimate your abilities, knowledge, or chances of success. Most people think they're above average at most things, which is mathematically impossible.
How Your Brain Does This
Your brain keeps your confidence high because confident people were more likely to survive and reproduce. It's better to be overconfident and take action than to be accurate and paralyzed by doubt. But this leads to poor financial decision-making.
Real-World Money Examples
Stock picking: You think you can beat the market by picking individual stocks, even though 90% of professional fund managers can't do it consistently. You focus on your winners and forget your losers.
Insurance decisions: You think you're a better driver than average, so you choose high deductibles or minimal coverage. When you have an accident, you're stuck with huge out-of-pocket costs. (Note: If you are truly a documented long-term safe driver, you should definitely raise your deductibles.)
DIY projects: You think you can remodel your kitchen for $10,000 and finish in two weeks. Six months and $25,000 later, you're hiring the professionals you should have called first.
Business ventures: You think your new business idea will definitely succeed, so you invest your entire savings without considering the 90% failure rate for new businesses.
Budget planning: You consistently underestimate expenses and overestimate income because you focus on best-case scenarios.
The Actual Cost
Overconfidence bias costs money through:
Active trading (costs 2-3% annually in underperformance)
Inadequate insurance coverage
Failed DIY projects
Business failures
Unrealistic financial planning
The average overconfident investor underperforms the market by $2,000-5,000 annually due to excessive trading. (source)
How to Overcome It
Track your predictions: Keep a record of your financial predictions and check them later. You'll quickly see you're not as good as you think.
Use base rates: Before making any financial decision, look up what happens to most people in similar situations. If 90% of restaurants fail, assume yours will too unless you have specific advantages.
Get external validation: Before making major financial decisions, get second opinions from unbiased sources.
Automate what you can't do well: If you can't pick stocks, buy index funds. If you can't stick to budgets, automate your savings.
Loss Aversion: Why Losses Hurt Twice as Much
What It Is
Loss aversion is your brain's tendency to feel losses much more strongly than equivalent gains. Losing $100 feels about twice as bad as gaining $100 feels good. (source)
How Your Brain Does This
Your ancestors who were more afraid of losing food than excited about finding it were more likely to survive famines. This asymmetric response to gains and losses kept humans alive but now causes poor financial decisions.
Real-World Money Examples
Sunk cost fallacy: You've spent $5,000 repairing an old car. It needs another $3,000 in repairs, but a reliable used car costs $8,000. You keep repairing because you can't accept "losing" the $5,000 already spent.
Holding losing stocks: You bought a stock at $50 that's now worth $30. You refuse to sell because that would "lock in" the loss, even though you'd never buy the stock at $30 today.
Subscription services: You keep paying for a gym membership you don't use because canceling feels like admitting you wasted money, even though continuing wastes more money.
Insurance over-buying: You buy comprehensive coverage for everything because the fear of potential losses outweighs the certain cost of premiums.
Avoiding the stock market: You keep money in savings accounts earning 1% because you can't tolerate the possibility of losing money, even though inflation guarantees you'll lose purchasing power.
The Actual Cost
Loss aversion leads to:
Continuing bad investments too long
Over-insuring against unlikely events
Under-investing in growth assets
Throwing good money after bad
Studies show loss-averse investors earn 2-4% less annually by avoiding stocks and holding losers too long. (source)
How to Overcome It
Reframe decisions: Instead of thinking about losses, think about opportunity costs. Keeping a losing stock means missing opportunities elsewhere.
Use systematic rules: Decide in advance when you'll sell investments (e.g., 20% stop-loss) and stick to it.
Focus on probabilities: Make decisions based on expected outcomes, not worst-case scenarios.
Automate investing: Dollar-cost averaging into index funds removes daily loss/gain emotions from investing.
Recency Bias: Why Yesterday Predicts Tomorrow
What It Is
Recency bias is your brain's tendency to give more weight to recent events when making decisions. What happened yesterday feels more important than what happened last year, even when it's not.
How Your Brain Does This
Recent events are easier to remember and feel more relevant than distant ones. Your brain assumes recent patterns will continue, which helped predict immediate threats but fails with long-term financial planning.
Real-World Money Examples
Market timing: The stock market has been going up for two years, so you invest more money right before a correction. Or it's been going down for six months, so you sell everything right before the recovery.
Investment strategy changes: Your aggressive portfolio lost money last year, so you switch to conservative investments right when aggressive investments are cheap.
Insurance decisions: Your neighbor's house flooded last month, so you buy expensive flood insurance even though floods happen rarely in your area.
Career decisions: Tech stocks crashed, so you avoid a job in tech even though tech still offers good long-term opportunities.
Real estate timing: House prices have been rising for three years, so you rush to buy before they go higher, not realizing you're buying at the peak.
The Actual Cost
Recency bias causes:
Buying high and selling low (opposite of good investing)
Changing strategies at the worst times
Over-reacting to short-term events
Missing long-term opportunities
Investors who make decisions based on recent performance typically underperform by 3-5% annually. (source)
How to Overcome It
Look at long-term data: Before making investment decisions, review 10+ years of data, not just recent performance.
Use systematic investing: Dollar-cost averaging and automatic rebalancing remove emotional timing decisions.
Make decisions based on fundamentals: Focus on underlying value, not recent price movements.
Wait 72 hours: After market volatility or major news, wait three days before making investment changes.
Availability Heuristic: Why Scary Stories Guide Your Money
What It Is
The availability heuristic is your brain's tendency to judge the probability of events based on how easily you can remember examples. Vivid, memorable events feel more likely than they actually are.
How Your Brain Does This
Your brain uses memory as a proxy for probability. Events that are easy to remember (because they're recent, emotional, or widely reported) feel more likely to happen than events that are hard to remember.
Real-World Money Examples
Over-insuring rare events: You buy expensive life insurance after reading about a plane crash, even though you're more likely to die from heart disease.
Under-insuring common events: You don't buy disability insurance because you can't remember anyone becoming disabled, even though it's much more common than death.
Investment fears: You avoid airline stocks because you remember news about crashes, ignoring that airlines are statistically very safe and profitable.
Home security spending: After watching crime shows, you spend thousands on security systems even though crime rates in your area are low.
Technology fears: You avoid online banking because you remember stories about identity theft, even though online banking is safer than mailing checks.
The Actual Cost
The availability heuristic leads to:
Misallocated insurance spending
Poor investment diversification
Avoiding beneficial technologies
Overreacting to unlikely risks
People typically over-insure against memorable risks and under-insure against boring ones, wasting thousands annually.
How to Overcome It
Look up actual statistics: Before making insurance or investment decisions, research actual probabilities, not memorable stories.
Consider base rates: What happens to most people in most situations? Use that as your starting point.
Distinguish between vividness and probability: Just because you can easily imagine something doesn't make it likely.
Get professional advice: Insurance agents and financial advisors can provide objective probability assessments.
Mental Accounting: Why a Dollar Isn't Always a Dollar
What It Is
Mental accounting is your brain's tendency to treat money differently based on its source, intended use, or location. You act as if different dollars have different values, even though money is fungible.
How Your Brain Does This
Your brain likes to categorize things into neat buckets to simplify decision-making. This worked well for physical resources (food vs. tools) but doesn't work well for money, which can be used for anything.
Real-World Money Examples
Tax refund spending: You get a $2,000 tax refund and spend it on a vacation, even though you have $2,000 in credit card debt. You treat the refund as "found money" instead of your own money.
Separate accounts inefficiency: You keep $10,000 in a savings account earning 1% while carrying $5,000 in credit card debt at 18% interest because they're in different "mental buckets."
Bonus money waste: You get a $5,000 work bonus and buy a luxury item, even though you've been struggling to save money. The bonus feels different from regular income.
Inheritance spending: You inherit $50,000 and spend it on things you'd never buy with earned money because inherited money feels "free."
Gift card premium: You'll spend $25 on a restaurant gift card but wouldn't spend $25 cash at the same restaurant because gift cards feel like "play money."
The Actual Cost
Mental accounting costs money through:
Suboptimal allocation across accounts
Higher borrowing costs while holding low-yield assets
Frivolous spending of "found money"
Reduced overall wealth optimization
The average person loses $1,000-3,000 annually by not optimizing across all their money.
How to Overcome It
Treat all money equally: A dollar is a dollar regardless of where it came from or where it's going.
Optimize across all accounts: Pay off high-interest debt before keeping money in low-interest savings.
Automate decisions: Set up automatic transfers so you don't have to make emotional decisions about different buckets.
Think total net worth: Focus on your overall financial picture, not individual account balances.
Status Quo Bias: Why Change Is Hard (And Expensive)
What It Is
Status quo bias is your brain's tendency to prefer things to stay the same. You stick with current situations even when better alternatives are available, simply because change requires effort.
How Your Brain Does This
Change requires energy and involves uncertainty. Your brain likes to conserve energy and avoid unnecessary risks. The current situation is known and safe, while alternatives are unknown and potentially dangerous.
Real-World Money Examples
Never switching services: You've been with the same bank for 10 years, even though online banks offer 10x higher interest rates. Switching feels like work.
Auto-renewal trap: You automatically renew your car insurance every year without shopping around, missing opportunities to save hundreds annually.
Old investment accounts: You have a 401k from a previous job with high fees, but you never roll it over to an IRA with lower costs.
Subscription accumulation: You keep paying for services you don't use (gym, streaming, magazines) because canceling requires action.
Bad financial advisors: You stick with an advisor who charges high fees and provides poor returns because finding a new one feels overwhelming.
The Actual Cost
Status quo bias costs through:
Overpaying for services year after year
Missing better investment options
Accumulating unused subscriptions
Staying in suboptimal financial situations
The average person could save $2,000-5,000 annually by overcoming status quo bias and optimizing their financial services.
How to Overcome It
Schedule annual reviews: Put "shop insurance" and "review investments" on your calendar every year.
Calculate opportunity costs: Figure out exactly how much staying put is costing you annually.
Make switching easier: Research new options before canceling old ones, so the transition is smooth.
Start small: Begin with easy switches (like online banking) to build momentum for bigger changes.
The Meta-Bias: Why You Think You're Immune
Here's the tricky part: there's a bias about biases. It's called the bias blind spot: the tendency to think you're less susceptible to biases than other people.
You might be reading this thinking, "This is interesting, but I don't really fall for these traps." That thinking is itself a cognitive bias.
The truth: Everyone has these biases. Smart people, educated people, wealthy people, we all make predictable errors in judgment. The difference between financially successful people and everyone else isn't that successful people don't have biases. It's that they recognize their biases and build systems to work around them.
Building Bias-Resistant Financial Systems
You can't eliminate cognitive biases, but you can design your financial life to minimize their impact:
Automate everything possible: Use automatic investing, bill pay, and transfers to remove emotional decisions from routine financial tasks.
Use systematic rules: Decide in advance when you'll rebalance portfolios, sell investments, or make major purchases. Write down the rules and follow them.
Get outside perspectives: Before making major financial decisions, talk to people who don't have skin in the game and will give you honest feedback.
Slow down big decisions: Wait 24-48 hours before making any financial decision over $1,000. Most biases lose power when you step away from the immediate decision.
Track your mistakes: Keep a record of financial decisions and their outcomes. You'll start to see patterns in your biased thinking.
Use checklists: Before making investment decisions, go through a checklist of potential biases. Are you anchored to irrelevant numbers? Are you being overconfident? Are you seeking confirming information?
The Bottom Line
Your brain is not your friend when it comes to money. It was built for a world of scarcity, immediate threats, and simple decisions. The modern financial world requires long-term thinking, complex calculations, and delayed gratification, all things your brain finds unnatural.
The good news: Once you understand how these biases work, you can design systems to work around them. You don't need to become perfectly rational. You just need to recognize when your brain is likely to sabotage you and have systems in place to prevent it.
The key insight: Financial success isn't about having perfect judgment. It's about recognizing your imperfect judgment and building systems that work despite it.
Most people fight their biases with willpower and lose. Smart people design systems that make good financial decisions automatic and bad financial decisions difficult.
Your brain will always try to sabotage your wealth. The question is whether you'll let it.
Next time, we'll explore the social and emotional money traps that cost you even more than cognitive biases.
Until then, your homework: Pick one bias from this post that you recognize in yourself and design a system to work around it. Maybe it's automating your investing to avoid recency bias, or scheduling annual insurance reviews to overcome status quo bias. Small systems create big results over time.
Here's to outsmarting your own brain,
Max
Remember: The goal isn't to eliminate biases. It's to recognize them and build systems that work despite them. Your future wealth depends not on perfect thinking, but on imperfect thinking with excellent systems.