Behavioral Finance 101: 7 ways your brain can sabotage your finances

Yahoo

11-05-2025

Have you ever avoided checking your bank account balance because you're afraid of what you'll see? Or splurged on an impulse purchase against your better judgment?
You're not alone. Our emotions can take over and lead us to make questionable money decisions. Understanding why this happens — and how to prevent it — begins with understanding behavioral finance.
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Behavioral finance is a field of study that explores how psychological factors influence financial decisions.
'It explains why people often make financial decisions that defy logic — like overspending, avoiding bills, or staying in debt cycles — not because they're irresponsible, but because emotions like fear, shame, and stress are driving the behavior,' said Nathan Astle, a certified financial therapist. 'It's about understanding the 'why' behind our choices, not just the numbers.'
People tend to have certain cognitive biases, which can negatively impact their financial decisions. Common biases include:
This is the psychological tendency for individuals to strongly prefer avoiding losses over achieving equivalent wins. For example, losing $100 typically feels more emotionally painful than the pleasure felt from gaining $100.
'Our decisions and actions with money tend to be driven by the fear of losing it rather than taking the risks needed to grow it,' said Dr. Dan Pallesen, a certified financial therapist.
That often causes people to make overly conservative, or even irrational, decisions with their money. For instance, you might hold on to a stock that's losing value longer than you should to avoid realizing a loss, even though you'd be better off selling it and reinvesting the money in a stock that's performing well.
Overconfidence bias is the belief that you know more about a particular subject than you really do.
This can lead to making uninformed financial choices, such as taking on too much investment risk without proper research or ignoring a financial advisor's recommendations. In other words, overconfidence bias can lead to expensive mistakes because your decisions are based more on self-assurance than objective analysis or hard evidence.
This is a cognitive bias that causes you to rely too heavily on the first piece of information you receive, and it serves as the 'anchor' for all future decisions. There are several ways anchoring bias can play out regarding your finances.
For example, let's say you want to purchase a home, and you see a listing for a house with a recent price reduction. You might feel compelled to put an offer in on this particular home because you're getting a good discount and saving money. However, further research may uncover that the property is still overpriced for the market or requires costly repairs that would cancel out any perceived savings.
As an investor, anchoring bias can occur when you focus on a stock's initial purchase price or recent highs, influencing you to hold a losing investment in hopes that it will rebound.
It's human nature to do something simply because everyone else is, like buying the latest iPhone when your current phone works just fine, or waiting in line for hours to try a new restaurant because it's gone viral on social media. This is known as herd mentality. But when it comes to your finances, hopping on the bandwagon can cost you.
For example, during a stock market rally, people may rush to invest out of fear of missing out, and during a downturn, they might panic-sell just because others are — regardless of whether it makes sense for their investment portfolio or risk tolerance.
Familiarity bias happens when people prefer things they recognize or understand easily versus situations that are new or complex. That's not always a bad thing, but when it comes to finances, familiarity bias can lead people to ignore better options in favor of what feels comfortable.
For example, you might stick with a traditional savings account from the national bank where you opened your first account 20 years ago, even though you could earn 10 times more interest on your savings by switching to an online bank.
This refers to the habit of treating money differently depending on where it came from. For example, you might receive your biweekly paycheck and immediately divide it into various budgeting categories to avoid overspending. But when you get your end-of-year bonus or tax refund, you're more likely to spend that money freely without factoring it into your budget — even though it's still income you worked for.
The gambler's fallacy is the belief that past events influence the probability of future outcomes in random situations. It's based on the concept of a gambler who's had several consecutive losses and believes they're "due" for a win — so they increase their bet, even though the odds haven't actually improved.
For investors, this can mean holding onto a stock because a series of losses means it is likely to rebound soon, or selling a stock because it's been up too long and is likely to plunge soon.
Ultimately, this is due to the nature of human emotions and a deeply rooted way of processing them to protect ourselves.
'Our minds are not wired for what we would consider good money decisions today. Our minds are wired for survival,' Dr. Pallesen explained. 'Our ancestors survived with minds that helped them avoid danger and binge the resources available to them in the moment. It is no different today with money.'
Allowing emotions to take the driver's seat when managing money is a dangerous game. It can impact your spending, saving, debt management, investment decisions, and more — ultimately keeping you from reaching your financial goals. But if emotions get in the way of sound financial decisions, it's not entirely your fault.
'We're not rational creatures when it comes to money; we're emotional,' Astle said. 'Many people carry 'money stories' shaped by early experiences, cultural expectations, and even generational trauma.'
For example, Astle said, if you grew up watching your parents argue about money, you may subconsciously avoid budgeting as an adult. However, you can take steps to change these behaviors. 'Real financial change starts when we recognize those patterns and create space for new, healthier behaviors,' Astle noted.
We asked experts for their best tips on overcoming emotions and behavioral biases to make smarter financial decisions. Here's what they said.
If you're saving for a specific goal, such as your child's college tuition or a family vacation, name your savings account to reflect it. That way, whenever you log into your bank account, you get an extra boost of motivation to continue saving for that goal.
Pallesen said visual cues are also a good way to inspire you to save and remind you of what's important. For instance, look at pictures of your kids before discussing household finances with your partner. Tape a picture of your favorite hobby to your computer monitor as a reminder of what you're looking forward to in retirement. Create a vision board with a friend to see and reinforce the things and values you're striving for in your life.
It's common to focus on losses, but try tracking your wins as well. 'A lot of people will monitor their account balances, but they are often reviewing things that are out of their control, like stock market movement,' Pallesen said. 'Instead, track your savings rate and compare it against your past.'
For example, he said, if you're currently saving 10% of your income this year, see if you bump that to 15% by the same time next year. Then track your progress in a spreadsheet or journal. 'Tracking and seeing progress is a great way to build momentum of healthy financial habits,' Pallesen added.
If you're debating an impulse buy, take a beat and put the purchase on pause for 24 hours. This gives you time to consider why you feel you need it and whether you can truly afford it. After some time, you may decide that the purchase isn't worth it, helping you avoid making an impulsive decision you'll regret later.
Don't be afraid to seek help from a trusted friend or financial therapist to help you navigate complicated feelings related to your finances. They may be able to help you see things from a different perspective and offer solutions to help you overcome these hurdles.
It's common to fear the unknown, but avoiding your bank account balances and budget will not help you feel secure in your money management. 'Make time for a short, guilt-free check-in with your finances,' Astle said. 'Light a candle, grab a snack — remove the dread and replace it with consistency and care.'
Read more: 5 psychological money hacks to cut spending and increase savings