Your students have to make thousands of decisions every day – from what clothes to wear to what information will be needed on a test to the best place to meet up with friends after class. To make decision-making easier, they rely on brain shortcuts known as biases. These biases are like educated guesses or rules of thumb that happen almost automatically and without much conscious awareness.
These behavioral biases are extremely useful, allowing students to make quick decisions without too much effort.
For example, when buying a new shirt at the store, a student might have a bias that suggests that name brands are better than store brands. Or they may have the bias that thrift shopping is a better bargain. Or they may have a bias that shopping at major retail outlets during a sale is the best time to shop.
No matter what their individual bias is, the student can go into a store and find a shirt without expending too much energy.
Unfortunately, according to a Morningstar report, Understanding the Financial Impact of Behavioral Biases1, not all behavioral biases are beneficial, especially when dealing with financial matters.
Which Biases Cause Problems?
Although the researchers looked at several potential financial biases, they found that four negatively affected financial health. These include:
- Present Bias: Preference to take a lesser reward now than a greater reward in the future
- Base Rate Neglect: Using readily available information to determine the likelihood of an event happening without looking at the most credible information
- Overconfidence: Believing that their knowledge, skills, or information is better than they actually are
- Overconfidence: Having a greater fear of losses than the reward of equal gains
The research found that if your students have one or more of these biases, they are more likely to have lower checking and savings account balances, smaller retirement savings, higher credit card debt, lower credit scores, and higher student debt. They are also likely to not pay their bills on time.
Of your student population, how many are affected by these biases? The research results discovered that 98% of respondents had at least one of the four poor financial health biases – many have two or more.
What’s more, poor financial health as a result of these biases holds true even when controlling for financial literacy and demographics.
Students Don’t Recognize Their Biases
The best way to reduce the effects of a bias is to know that a bias exists. Unfortunately, your students are unlikely to recognize the bias on their own.
Even taking financial literacy courses in which they learn facts and the need for behavioral changes doesn’t stop them from making poor financial decisions because the bias is in the driver’s seat.
That’s why offering a robust financial wellness program that explores these biases with students will help them understand their relationship with money and gain financial health.
To that end, iGrad offers a financial wellness assessment called Your Money Personality that is similar to the Myers-Briggs Type Indicator. This tool assesses student financial behaviors across:
After taking the assessment, students understand their strengths and challenges, as well as their dominant traits. Then, students are guided to take specific actions that capitalize on their strengths and reduce the effects of their challenges.
As they come to understand their inherent biases, students can work toward making long-term changes toward financial health.
Understanding the Present Bias
Students with a present bias may be seen as impatient or needing immediate gratification. That’s because they are more likely to choose a lower payout today rather than wait for something better later.
Those with a present bias are more likely to spend more money than they make, often making up the difference with credit cards and high-interest payday or title loans.
When a student with a present bias takes the “Your Money Personality” assessment, they may find themselves in one of these categories:
- Present-Focused: Does the student live for the day? Do they assume everything will work out in the end? Do they assume everything works out even if they choose to do nothing about it now? Do they know the behaviors they need to take but have no idea how those behaviors affect their financial future? If so, they may be present-focused.
- Fun-Seeker: Does the student see money as a means for enjoying life? Do they love shopping sprees and treating themselves? Do they live the YOLO (you only live once) motto when it comes to money? If so, they may be a fun-seeker.
- Relaxed: Is the student unconcerned about money? Going into debt? Do they enjoy spending money without thinking about how they will pay off the debt later? So they only consider how spending money makes them feel in the here and now? If so, they may be relaxed.
Of course, having a present bias has some benefits. For instance, these individuals are often generous with their money, optimistic about the future, and great at budgeting for short-term events like a specific shopping excursion. However, they face challenges like being in debt and not having enough money set aside for emergencies.
The “Your Money Personality” assessment helps students see the positive and negative, then offers some advice. For a student with a present bias, the advice might be:
- Begin to save money for emergencies
- Use online bill pay to make sure bills are paid on time
- Don’t purchase items online immediately – instead, place items into a wishlist and wait 48 hours
Understanding Base Rate Neglect Bias
With technology, information is at your students’ fingertips all day, every day.
When making financial decisions, students with base rate neglect bias may lean heavily on readily available information to determine the likelihood that something will happen.
Let’s look at credit scores, as an example. Students can easily discover what factors most influence credit scores. They can also find plenty of articles explaining how to quickly and easily fix credit score problems.
This may lead some to believe that their actions will have little lasting effect on credit scores, which may be why the researchers found that those with base rate neglect bias are 11 times more likely to have a bad credit score.
Students with base rate neglect bias may fall into one or both of these categories when taking the “Your Money Personality” assessment:
- Change-seeker: Does the student seek adventure? Do they get bored easily? Do they enjoy spending money on experiences? Are they unlikely to think a financial decision through to determine the overall cost or future financial implications? If so, they may be a change-seeker.
- Optimistic: Does the student feel hopeful about the future? Do they believe things will work out? Do they shun planning for the future because they believe it all works out in the end? If so, they may be optimistic.
On a positive note, those who have base rate neglect have little financial stress and aren’t afraid to take financial risk.
On the other hand, they are less likely to save for the future, spend money without thinking, and take out excessive student loans without considering the consequences.
For students with this bias, “Your Money Personality” would suggest such actions as:
- Creating a savings account for future experiences
- Making a list of all costs before making a big financial decision, such as taking out a student loan
- Putting all financial information together in one place to get a complete understanding of the financial picture
Understanding the Overconfidence Bias
Many of your students believe they understand finances enough to make wise decisions. However, due to the lack of financial literacy in schools and the taboo nature of financial talk among family members, it is likely that they don’t have all the information they need.
This leads students with this kind of bias to have less money in savings than they need and eventually will lead them to save less for future events such as buying a new home or retirement.
“Your Money Personality” often puts those with overconfidence bias into these categories:
- Independent: Is the student self-reliant? Do they shun seeking advice from others? Do they prefer to do their own research? If so, they may be independent.
- Confident: Does the student make quick, efficient financial decisions? Do they rely solely on the information they have in their head? Do they assume they know the answers to financial questions despite not knowing the answers? If so, they may be confident.
Those with overconfidence bias tend to be responsible with their money. They also don’t get trapped by peer pressure and the need to keep up with others financially.
However, these students are also less likely to take note of warning signs or listen to the advice of experts.
For students with overconfidence bias, the assessment recommends actions such as:
- Evaluating sources of available information
- Getting a second opinion when taking a financial risk
- Understanding your potential future income based on your college major
Understanding the Loss Aversion Bias
A student with loss aversion prefers to avoid losses when compared to gaining something of equivalent value. In fact, some suggest that students with loss aversion suffer twice as much with loss as they could get in happiness with gain2.
The study found that those with loss aversion bias were much more likely to have lower 401(k) savings, or, in other words, were less likely to choose to make investments.
Those with loss aversion bias may find that “Your Money Personality” assessment puts them in one of two (or both) categories:
- Skeptical: Does the student have low expectations that things will work out financially? Do they fear taking a risk? Do they think investments won’t pan out? If so, they may be skeptical.
- Apprehensive: Does the student worry about money? Do they second-guess their financial decisions? Do they have fear about unexpected finances? Are they constantly thinking about money even when they have enough? If so, they may be apprehensive.
There is nothing wrong with a little bit of loss aversion. In fact, those who are loss averse are less likely to fall for a scam and more likely to ask, “What’s the catch?” when confronted with information that seems too good to be true.
On the other hand, someone with loss aversion is less likely to invest. If a student doesn’t begin investing young, they will never reap the full potential of their money.
Some actions for those with this bias might be to:
- Look at best-case scenarios when considering different financial options
- Work toward many small money goals
- Create concrete, easy-to-take steps that move you toward your goals
- Create a visual budget and project it out with best-case scenarios
Without a doubt, the majority of your students have biases that negatively affect their financial health now, and these biases will continue to do so in the future unless addressed.
Institutes of higher education have an opportunity to provide students with tools that help them recognize these biases and overcome them to gain financial wellness.
Those using the Your Money Personality assessment have found that understanding their profile and following the guidance has helped them make better decisions and reduce their financial stress – in other words, reduced their biases and increased their financial health.
1 - https://www.morningstar.com/lp/impact-of-behavioral-biases
2 - https://thedecisionlab.com/biases/loss-aversion