How Confirmation Bias Can Sabotage Your Money

Plus three tips to overcome confirmation bias

Confirmation bias is the tendency to seek out and interpret new information in such a way that reinforces their prior belief.

Confirmation bias can impact your thinking in three ways.

It causes you to seek out information that backs up what you already believe.
Even when presented with evidence that refutes your prior belief, you’ll interpret that information (incorrectly) in a way that aligns with your priors.
It distorts your memories. Research has shown that investors believe they are good at trading stocks; they remember having greater investment returns than they actually experienced.

In this article, I review two specific ways in which confirmation bias can hurt your finances.

#1 — Your career

As I’ve written in the past, the most important financial decision you’ll ever make is how you choose to make money.

The two most important assets in life are:

Time and;
Money

What line of work you do and whether you choose to be a 9–5 employee or business owner will dictate how much money you earn in your life and how you spend the majority of the working hours in the prime years of your life.

If you have preconceived notions of what the “right” way to make money is, you’ll set yourself up for disappointment.

I once wrote that no group of people in society is deified more than entrepreneurs. I’d like to amend that statement; no group of people in society is more deified than solopreneurs — or the “1 person” business.

I am an example of a solopreneur. I am a one-man business that runs a personal finance website (the one you’re reading) and publishes books on investing and personal finance. Apart from my wife, who helps with graphic design and proofreading, it’s just me running Making of a Millionaire.

Influencers would have you believe solopreneurship is effortless, mega-profitable, and glamorous. I am here to tell you that it’s hard as hell, profits are volatile, and there’s little glamor in the work that goes into keeping this ship afloat.

But if you feel; in your bones that solopreneurship is the best way to make money, then you’d be likely to ignore people who tell you that running a one-person business is not all it’s cracked up to be.

If you start a solo business as a side huslte, then all you risk losing is time, and whatever startup costs are required.

If you dive in feet first and make a solo business your full-time job, things can get ugly quickly. Most businesses fail, and most solopreneurs never crack $1,000 in monthly income.

This isn’t so bad if you have a lot of money to fall back on or a spouse who makes enough to cover your living expenses. But if you are the breadwinner in the family, quitting your job to go full-time in a business can be devastating if the business goes belly up.

Successful entrepreneurs and solopreneurs usually fall into one of two camps:

Rich people who have the luxury of going without income for an extended period of time.
Hustlers who maintain their business as a side hustle, working two full-time jobs until the business is making steady profits.

It’s not just a bias toward entrepreneurship. Many people believe the only way to get ahead is to get a 4-year degree, so they are willing to take on six figures in debt to make that happen.

Many people’s career choices are guided by confirmation bias, never stopping to consider if they might make more money or be happier doing another type of job. As a result, they leave money on the table and spend too much time doing work they don’t like.

#2 — Whether you rent or buy your home

The eternal debate in personal finance is whether it makes more financial sense to rent or buy your home.

There are two schools of thought on rent vs. buy.

The ownership crowd who believes that owning a home is better than renting. The central argument here is that paying rent is throwing your money away. You’ll often hear arguments from this crowd like “paying rent is simply paying someone else’s mortgage.”
The renting crowd believes that renting a home is better than owning one. The central argument here is that a house isn’t really an investment. You’ll often hear arguments from this crowd like, “a house costs you money, and therefore it should be treated like a liability rather than an asset.”

This debate will literally rage on for eternity, in large part thanks to confirmation bias.

Few financial decisions are as emotionally loaded and consequential as deciding what kind of home you want to live in and whether you rent or buy. So, many people are so deeply entrenched in their view that those in the ownership camp will never consider renting, and those in the renting camp will never consider buying.

The reality is that there is no universal right answer, so refusing to consider the opposing viewpoint can be very costly. From a financial perspective, renting vs. buying is about answering three questions.

How much does a home in your area cost to buy?
How much does a comparable home cost to rent in the same area?
If renting turns out to be cheaper, what will you do with that extra cash?

A) Determining the cost to buy a home, you need to factor in all the upfront costs — down payment, taxes, legal & realtor fees, etc. — and all the ongoing costs — property taxes, mortgage payments, insurance, utilities, maintenance, homeowners association fees.

B) The cost to rent a home is more straightforward; damage deposit + monthly rent + utilities + renters insurance.

Then the question for renters is if B < A, what will you as a renter do with the extra money?

Your rent payments are not going to pay down the principal of a mortgage. This is a point the homeownership crowd uses to say, “AH HA! See, owning is always better!”

Except, that’s not inherently true. A renter can still build more wealth than an owner in the long run if they use the money they saved as a renter and redirect it to investments. (more in that in this post explaining the “5% Rule.”)

3 quick tips to avoid confirmation bias

Debate yourself. If you believe buying a house is the only viable option, pretend like you’re debating yourself and make a list of arguments in favor of renting.
Admit you don’t know it all. Being aware of confirmation bias and how prevalent it is in all areas of your life is the first step in avoiding the worst pitfalls of confirmation bias.
Get an objective 3rd party opinion on important decisions. For really important decisions, paying for financial advice is a no-brainer.

Remember, like all cognitive biases, you’ll never eliminate confirmation bias. The goal is not to let it drive your decisions.

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