Key Terms in Behavioural Finance Every Everyday Reader Should Know

Loss Aversion

The tendency to feel the pain of a loss roughly twice as intensely as the pleasure of an equivalent gain. For example, losing $100 feels significantly worse than gaining $100 feels good. This can cause people to avoid sensible risks or hold onto losing investments too long.

Anchoring

Anchoring happens when a person over-relies on the first piece of information they encounter — the 'anchor' — when making decisions. A common example is seeing a product marked down from a high original price and assuming the sale price is a great deal, regardless of actual value.

Mental Accounting

The habit of treating money differently depending on where it came from or where it's 'earmarked' — for instance, spending a tax refund freely while being cautious with the same amount earned through regular income. In reality, a dollar is a dollar regardless of its source.

Present Bias

A tendency to overvalue immediate rewards compared to future ones, even when the future reward is objectively larger. Present bias is a common driver of impulse spending and under-saving for retirement.

Status Quo Bias

The preference for keeping things as they are rather than making a change, even when changing would be beneficial. This often explains why people stay in low-interest savings accounts or keep unnecessary subscriptions running.

Herd Behaviour

Following the financial decisions of a large group, often without independent analysis. During market booms or crashes, herd behaviour can drive people to buy at peaks or sell at lows — the opposite of sound strategy.

Overconfidence Bias

Overestimating one's ability to predict outcomes or manage risk. Overconfident investors may trade too frequently or take on more risk than their financial situation warrants.

Sunk Cost Fallacy

Continuing to invest time, money, or effort into something because of what has already been spent, rather than assessing whether continuing makes sense going forward. Past costs are gone and cannot be recovered — only future costs and benefits should guide current decisions.

Availability Heuristic

Judging the likelihood of an event based on how easily examples come to mind. After hearing about a friend's stock market loss, for example, a person might overestimate the risk of investing — even if the statistical picture is more nuanced.

Nudge

A subtle design choice in how options are presented that steers people toward a particular decision without restricting choice. Auto-enrolling employees in retirement savings plans unless they opt out is a widely studied nudge.

Framing Effect

The way information is presented influences how it is received and acted on. Describing a savings account as having a '95% success rate' feels different from saying it has a '5% chance of falling short,' even though both convey the same information.

Cognitive Dissonance

The discomfort felt when holding two conflicting beliefs or when behaviour conflicts with values — such as wanting to save money while continuing to overspend. People often resolve this by rationalising their behaviour rather than changing it.