The Status Quo Bias in Personal Finance and Investing

For decades, economics and finance relied on a central assumption for its theories: that people acted in a rational manner.

Most people knew that this assumption could not be completely correct, as we all know a crazy relative or two who behaves irrationally. And people have always been making incorrect economic and financial decisions in their lives.

But the idea that almost everyone behaves irrationally in their financial decision-making was popularized by a pair of economists, Daniel Kahneman and Amos Tversky. Beginning with their work in the 1970s, they brought psychology into economics, and the field of behavioral economics was born. Daniel Kahneman shared the Nobel Prize in Economics in 2002 for his work, and Richard Thaler won the 2017 Nobel Prize for his work in behavioral economics.

There are many cognitive biases that Kahneman, Thaler, and other behavioral economists have discovered over the years, affecting the way that we invest and manage our finances. Let’s look at one of these biases: the status quo bias.

The Status Quo Bias

The status quo bias is defined simply as our tendency to resist change, even if it might be financially optimal to do so.

There are many logical reasons why people might prefer the status quo. Emotionally, the status quo is familiar. Change is not easy, and it’s often easier to avoid the uncertainty of change and stay with the status quo.

There is also cognitive effort required in evaluating a change. No one makes changes in their life for no reason, and in order to make changes, you need to expend a lot of cognitive effort. Many times, the change is not necessary. We only have so much mental bandwidth before we begin to develop decision fatigue, and sticking with the status quo helps reduce the number of decisions we have to make.

There are non-cognitive reasons why it might make sense to stick with the status quo. Many changes in personal finance and investing have transaction costs that inhibit change. You might have to pay taxes to sell those high-expense mutual funds or pay an early termination fee to switch cell phone providers.

Other cognitive biases interact with the status quo bias. For example, the endowment effect, when we value things more simply because we own it, can contribute to the status quo bias. If an item is worth more to you because you own it, you are less likely to part with it.

Loss aversion also contributes to the status quo bias. Our fear of losing money is greater than our satisfaction from gaining money. Because we’d rather keep what we have rather than take a chance at losing money, we tend to stick with the status quo.

Examples of the Status Quo Bias

Mutual Fund Selection

When we select mutual funds, we have a tendency to stick with them, even if better options may become available in the future. This was first postulated theoretically by Paul Samuelson and Richard Zeckhauser in 1988, but was confirmed empirically in a 2006 study, where investors chose to stick with prior mutual fund choices, even if better mutual funds were now available.

Choosing a Brokerage

There are many good brokerages where you can invest your money. For investing in low-cost index funds, the largest brokerages are Vanguard, Fidelity, and Schwab. There are few differences between their fund offerings (especially their expense ratios), and once you have chosen one brokerage, the status quo bias makes it difficult to switch to a different brokerage.

Even large sign-up bonuses, which Fidelity used to offer, might not convince some investors to switch funds.

Get Them When They’re Young

When I was a freshman in college, banks would be all over campus trying to get you to open an account with them. They knew that if they could get you when you were young, you could potentially stick with them for a lifetime. I signed up for a Bank of America bank account and credit card as a college freshman, and I still have both of these accounts to this day.

Switching Auto Insurance or Cutting the Cord

It can be mentally difficult to switch auto insurance companies. I currently use Progressive for my auto insurance, and they try to encourage the status quo bias by emphasizing how I’ve been a member with them since 20XX, even though I could call their rival and save 15% or more on my car insurance in 15 minutes.

Avoiding the Status Quo Bias

Have an Annual Meeting

Just like Berkshire Hathaway or any other major company, you should have an annual meeting where you assess all of your financial accounts and investments. You should evaluate your budget and see where you can trim the fat and reduce expenses. This is an opportunity to bust out of your status quo bias and make small recurrent changes that can add up to significant money over time.

Re-evaluate your recurring purchases on a regular basis

In between your annual meetings, you should periodically evaluate your recurring expenses and see whether there are places where you can save money. Is there a cheaper wireless plan you could be using? Do you really watch all 374 channels on your television? Could you go to a cheaper gym? Are you maximizing your credit card rewards or cash back from online purchases?

Use the status quo bias to your advantage — avoid lifestyle inflation

The status quo bias often works against you, but in some cases you can use it to your advantage. Stay in your resident house or apartment when you graduate and don’t move into that attending home. Don’t trade in your old car for a shiny new luxury car for a couple years. A short “financial fellowship” following residency, where you spend like a resident on an attending salary, will help you quickly pay off your student loans and put you on the path to financial independence.

Conclusion

The status quo bias impedes us from making beneficial financial (and other) changes in our lives. By being cognizant of this bias, we can thoughtfully choose to keep the status quo, or make changes that improve our lives.

What do you think? In what areas have you been prone to the status quo bias? Is there a financial decision that you have been putting off recently?