What is... | July 10, 2017

What is projection bias?

Our present situation can cloud our view of the future – and cause problems for our finances.


Have you ever gone shopping on an empty stomach, thrown a load of unhealthy food into the trolley and then later, after dinner, wondered why you bought all that junk?

Or booked an overly long beach holiday, mistakenly thinking that the 12th day lying on the sand would be just as enjoyable as the first?

If the answer is yes, then you know what it’s like to fall foul of what behavioural scientists call “projection bias”.

In their seminal paper, economist George Loewenstein and colleagues described it as what happens when we expect our current tastes and preferences to continue in the future and underestimate the magnitude of change.

The present situation clouds our view of the future  – so when we’re ravenous, we act as if our future taste for food will reflect that hunger. Or when we’re stressed, think we could spend forever on a beach.

And it can influence our finances in all sorts of ways.

Spend now - regret later
It’s the reason our spending habits can be overly affected by the weather, according to researchers from the US National Bureau of Economic Research. They found that people are more likely to buy a convertible on a sunny day, or pay significantly more for a house with a swimming pool in the summer than in the winter.

And those of us who have ended up paying through the nose for a gym membership we barely use – as this study by the University of California Berkeley and Stanford describes – may have done so because we couldn’t keep up with the high expectations of ourselves that we enthusiastically projected into the future.

Expensive gadgets that now languish on a shelf may have been bought because our projections prevented us from realising how quickly the novelty would wear off. It’s similar to the empathy gap, where the decisions we make in an emotional “hot state” are often at odds with those we make when we’re in a calm “cold state”. 

Keeping up with the Joneses
Projection bias is also linked to social comparison theory – the way we determine our own worth based on how we stack up against others.

According to Loewenstein and team, projection bias can happen when people make status-based decisions that cause them to compare themselves to a different group of peers  – such as buying a better house in a new neighbourhood.

They may not understand that they will begin rating themselves against a different group of people.  

So they might continue to chase bigger and better things because they can start focusing on the larger houses and bigger cars their new neighbours have.

Planning problems
In the UK, the Financial Conduct Authority has warned that projection bias can encourage people to take out unsuitable financial products.

It can cause savers to tie up funds in long-term contracts – when in fact they might need that money before the deal matures.

Or it can lead borrowers to underestimate how much they will spend on a credit card in the future. Lenders may offer cheaper credit today – and increase the interest rates later. 

Insurance experts say people may end up spending too little on important products like health cover because they assume their current good health will continue into the future. In a similar way, people often don’t save enough for retirement.

Loewenstein and colleagues writes that this is due to habit formation throughout a person’s lifetime. As time progresses, people get used to consuming more, so saving falls short of intentions.

Additionally, the greater consumption levels mean they also value income more highly, so they end up putting retirement off until later than planned.

Time to cool off
EU legislators introduced “cooling-off” laws that may help combat projection bias.

Not only can these laws help us avoid buyers’ remorse  – we can take the item back if we realise it’s not what we need – they may actually reduce the incentive for a salesperson to “hype” up the item because returns can prove costly for the seller.

Anything we can do to help ourselves mentally time travel to the future may help us recognise that life – and our preferences – might be different then.

SavingShoppingEmotionBehaviourRetirementMoney

eZonomics team
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