Studies suggest the concept of "cognitive dissonance" holds the answer to the question: “If I don’t feel comfortable with what I am doing, should I change my belief or change my behaviour?” This has implications for the way we spend and save, and explains why some purchases don’t provide the “feel good” buzz that others do.
I do what I say and do what I do
Cognitive dissonance describes the distressing mental state people often feel when they find themselves behaving in ways which don't fit with their self-image, or having opinions that do not fit with other opinions they hold. The concept was discussed back in 1957 by American social psychologist Leon Festinger. The reasoning is that people desire to be consistent and will go out of their way to make sure their actions fit their beliefs and opinions. This suggests we are sensitive to inconsistencies between our actions and beliefs.
Solving a personal debt dilemma
If you believe it is wrong to be in debt, for example, yet you find yourself spending increasingly on your credit card, the theory goes that recognition of this inconsistency will cause negative feelings, and this will motivate you to resolve it. This resolution will happen in one of three basic ways:
1: You change beliefs (“it’s ok to be in debt”),
2: You change your actions (by reducing your spending or debt),
3: You change the perception of your actions (“everyone has a credit card these days; this isn’t real debt”).
Cognitive dissonance in share markets
Cognitive dissonance is found in other areas of financial decision making beyond spending. In a study by William Goetzmann and Nadav Peles in the Journal of Financial Research, the researchers show that even highly-informed and successful investors tend to irrationally alter their perception of their investment performance when performance is poor.
In other words, the investors revised their attitudes about the shares in an effort to reconcile the contradiction between the shares bad results and their self-image as a “good investor”. Support for the theory can even be found in studies of the brain. In the journal Nature Neuroscience Vincent van Veen and colleagues investigated the neural basis of cognitive dissonance using brain scanners.
While in the scanner, participants were asked to argue that being stuck in the machine was in fact a pleasant experience (it isn’t). This meant participants experienced cognitive dissonance between what they said and what they felt.
Their reactions demonstrated that those asked to say they enjoyed the experience actually really did enjoy being in the machine more, suggesting the experienced cognitive dissonance made them change their beliefs about the experience.
Practical lessons from the theory
A key message from the research is to recognise that we have a desire for consistency between our actions and our beliefs. And we should take this into account when deciding how to behave. As with every financial decision, careful planning and recognition that our emotions and psychology affect how we behave is a crucial step in ensuring that we don’t fall victim to irrational behaviour.
An idea is that if you begin making financial decisions which don’t fit with your self-image, change your behaviour – and not how you see yourself. The danger of changing the way you see yourself to fit in with your actions is the risk of making bad financial choices for years to come.