Money Mindset Quiz: How personal biases can impact your financial decisions

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People make money decisions based on a lot of factors including their short-term needs, financial goals, and available resources. Emotions and biases we may have about money can also play a role, oftentimes without us even realizing it's happening. Their influence can be especially strong when we're faced with complex or stressful situations, sending our financial decision-making off course.

Research has demonstrated that when people face complex decisions, there is a natural impulse to fall back on gut feelings or our own rules of thumb to simplify the situation. The problem is that those instincts don't factor in the long-term planning that a sound financial strategy requires.

— Nevenka Vrdoljak,
senior qualitative analyst,
Chief Investment Office, Merrill and Bank of America Private Bank

You don't have to wait until your biases interfere with your financial life to do something about them. Take the quiz below to test your gut reactions to some common situations. Learn what biases may be at play and what you can do about it!

Question 1:One day you decide to check out the value of your home on a real estate website. You're surprised to see that the value has decreased. What's your first thought?

I should consider selling before the value drops any further

People tend to remember the pain of financial losses more than the joy of equivalent gains. This natural focus on the negative can trigger a behavior known as loss aversion — an overreaction in which you try to avoid short-term losses at the cost of missing out on larger long-term gains.

Before you make a financial decision, be mindful of your long-term goals — for example, a big picture plan to build wealth in your home. If you don't have any plans to sell your home soon, try to avoid checking on the price every day — it'll help keep you from dwelling on the ups and downs of the housing market until it really matters to your plan.

I'm disappointed, but I'm not planning on selling anytime soon

This is a good attitude because you're reminding yourself of your big picture goal. For most people, homebuying decisions are driven by longer-term life needs — like raising a family or being close to work. However, short-term ups and downs in the home market can trigger what's known as recency bias: the tendency to put extra weight and focus on more recent events even when the long term is still favorable.

Another common example of recency bias can occur when checking in frequently on a long-term retirement account like your 401(k) balance. Recency bias can lead you to put extra weight on short-term changes in value that you wouldn't notice over the long term and could in turn influence you to change course on your long-term goals. Historically, home values (and markets) have increased in value in the long run, so patience and big picture thinking is the right move.

Question 2:You have some extra money and are considering how to use it. Which action do you feel most strongly about?

Paying down my student loans. I hate having them hanging over me.

Debt can feel like a burden to many people, even when it is debt that helps you achieve a goal. But consider that you might be exhibiting tunnel vision by focusing solely on the goal you are most emotionally attached to — paying off your student loan — rather than evaluating all your options.

While paying off student loans earlier will save you on future interest payments, could your money be better spent? For example, if you have a credit card balance, compare the interest rate of your student loan to the rate on your credit card. Applying the extra money to higher-interest credit card debt instead would do more to save on interest over the long run. To avoid tunnel vision, it's always a good idea to take your time with financial decisions and consider all your options.

Putting it towards my retirement savings

Thinking long-term can be difficult, so good for you on making this a priority. It's common for 'extra' money to trigger an impulse to spend it on something flashy — like the latest new phone or gadget — but this can be an example of "thinking too fast."

Slowing down your decision-making gives you a chance to consider other options like your longer-term savings goals. For example, investing in a tax-advantaged retirement savings account — like a Roth or traditional IRA (if you're eligible) — is a powerful way to help you save for the future.

Question 3:You're planning to invest some money in a stock. How do you decide what to invest in?

I just go with whatever is getting the most buzz online

Seeing a stock gain popularity may increase your desire to jump on the bandwagon without first doing your own research to determine if the investment is the right choice for your portfolio. This is an example of herd mentality — a bias where investors tend to follow the crowd and do what everyone else is doing, regardless of the crowd's expertise or reasoning.

The key to mitigating the effects of herd mentality starts with doing your due diligence. Developing a point of view based on your own research can help you build confidence to decide if buying a particular stock is a smart choice for you.

There's a company I'm excited about, so I do some research to see if I should invest in it

Whether you do your own online research or ask other people for their opinions, be aware that confirmation bias can come into play. Human beings tend to find information confirming their beliefs more compelling than information that contradicts them. So, although your research may turn up both pros and cons about the company you're interested in, your mind may put extra weight on the pros and dismiss the cons.

One way to reduce the effect of confirmation bias is to consciously seek out contradictory opinions to challenge your views, working to disqualify ideas you like, rather than confirm them.

Question 4:You are booking a long-awaited trip when you suddenly realize that a large bill is about to come due. What would you do?

I try to forget about it — I can't think about this bill when I have a vacation to plan!

No one likes surprise expenses, especially if they have a major impact on our budget and goals. The ostrich effect refers to our tendency to hide from problems that feel too overwhelming or stressful to confront.

Just being aware of the ostrich effect can help you avoid it, but another strategy is to think through "if/then" statements ahead of time to prepare yourself for tough financial situations. By considering options you might use to cover an unexpected cost — like building an emergency fund — you can avoid the unprepared feeling that might cause you to hide from important problems.

I immediately cancel all my plans — I can't think about my vacation with this bill looming over me!

Stressful problems can sometimes trigger a desire to take drastic action, but overreacting can lead you astray from your goals just as much as ignoring the problem can. One of the best ways to combat this bias is to slow down and create a plan — rather than acting quickly in the heat of the moment.

Before canceling your trip to pay your bill, take a closer look at your vacation costs. You may be surprised to learn that making adjustments to your trip might uncover some extra funds to help pay your bill — without leading to an overreaction like canceling your vacation altogether. This advice also applies to your investments. While news of market drops or surges can create an impulse to act quickly and strongly in response, this overreaction can lead to buying at the top and selling at the bottom.

"Being aware of our own habitual patterns of thinking is essential to making good financial decisions. These patterns can often lead us to think we possess special knowledge that we do not have, that we should follow the crowd when we shouldn't, or that responding to recent events is more important than sticking to our long-term goals."

— Anil Suri,
portfolio construction and investment analytics executive,
Chief Investment Office, Merrill and Bank of America Private Bank

Did any of your answers reveal behaviors that strike a chord with you? For better or worse, we all have unconscious biases and emotional reactions that impact our financial decisions, increasing the risk of financial missteps. The key to mitigating their negative impacts is being mindful of them. Make a note of the behaviors you encountered in this quiz, and when similar scenarios arise in life, take a moment to slow down your decision-making process. Consider your reactions in light of your financial goals and the plan you've made to achieve them.

Next steps

Learn about setting and prioritizing your multiple financial goals
Want to save more for the future? Explore different types of retirement savings accounts
Connect with a Merrill advisor to find out how one-on-one advice may help you with your financial decisions

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Money Mindset Quiz: How personal biases can impact your financial decisions

Question 1:One day you decide to check out the value of your home on a real estate website. You're surprised to see that the value has decreased. What's your first thought?

Question 2:You have some extra money and are considering how to use it. Which action do you feel most strongly about?

Question 3:You're planning to invest some money in a stock. How do you decide what to invest in?

Question 4:You are booking a long-awaited trip when you suddenly realize that a large bill is about to come due. What would you do?

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