Smart Money Podcast: How to Overcome Common Psychological Financial Mistakes: Framing, Loss Aversion, and the Gambler’s Fallacy

Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions. In this episode:

Learn how to control your behavioral economics biases and whether it’s ever worth it to use a credit repair service.

Behavioral Economics Biases: How can you master the psychology behind your financial decisions? Are credit repair services really worth the investment? Hosts Sean Pyles and Sara Rathner discuss behavioral finance biases to help you understand the psychological factors that influence your financial choices, including loss aversion, framing, and the gambler’s fallacy, also known as the Monte Carlo fallacy or the fallacy of the maturity of chances. They share tips and tricks on matching investments with your time frame and risk tolerance, resisting the influence of framing on your choices, and avoiding frequent checks on market fluctuations.

Money Question: NerdWallet credit writer Amanda Barroso joins Sean and Sara to answer a listener’s question about credit repair services. They explain the purpose and costs of credit repair services, the red flags that indicate a scam, and how you can manage your credit yourself effectively for free. They also tackle the pressing question of whether credit repair services can actually improve your credit score. Their conversation explains strategies for DIY credit repair, the importance of identifying and disputing inaccuracies on credit reports, and the role of credit counseling agencies for personalized financial planning.

Check out this episode on your favorite podcast platform, including:

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• Spotify

NerdWallet stories related to this episode:

How Behavioral Economics Can Help You Save on Airfare

Should You Use a Credit Repair Service?

6 Ways to Rebuild Credit

Have a money question? Text or call us at 901-730-6373. Or you can email us at [email protected]. To hear previous episodes, go to the podcast homepage.

Episode transcript

This transcript was generated from podcast audio by an AI tool.

Sean Pyles:

Hey, Sara, how do you keep yourself from making impulsive, irrational financial decisions?

Sara Rathner:

Well, I tend to shop online more than I do in person, but I still window-shop, so to speak. So I'll browse and if there's anything I like, I'll make a mental note or even add it to my cart. Then I'll stop and not go through with the purchase, go do something else, close the browser. And if I'm still thinking about that item a couple days later, or if I see that it goes on sale, then I'm more likely to buy it.

Sean Pyles:

I like that approach. Well, this episode will give our listeners some tips for getting the better of their own behavioral biases. Welcome to NerdWallet's Smart Money Podcast, where we help you make smarter financial decisions one money question at a time. I'm Sean Pyles.

Sara Rathner:

And I'm Sara Rathner. This episode we answer a listener's question about credit repair services. Are they really worth the cost and what can they even do for your credit?

Sean Pyles:

Spoiler alert, I think that credit repair companies are crooks, but we'll get to that later. First, Sara and I want to play armchair psychologists or more like armchair behavioral finance people. We're going to help you understand three ways that your own psychological biases might be preventing you from achieving your financial goals.

Sara Rathner:

This little segment is inspired by the late Daniel Kahneman, Nobel Prize winner and one of the founding fathers of behavioral economics. He passed away in late March at 90 years old. Kahneman upended decades of research about how people interact with money and the economy.

Sean Pyles:

Turns out we're not the rational ultra informed decision makers that many economists believed us to be. But understanding how your brain gets in the way of your own best intent can help you course correct or maybe even avoid making bad financial decisions in the first place. So Sara, what is the first behavioral bias that people might encounter?

Sara Rathner:

First one is called loss aversion. This one may be Kahneman's most famous contribution. So basically the idea is that the pain of losing money is greater than the joy we experience getting money. So let's look at it when it comes to something like investing. This means that sometimes people will structure their portfolios in a very careful way to avoid losses instead of setting up a portfolio that might be a little bit riskier, but could potentially provide greater returns over time, or they might avoid investing entirely.

Sean Pyles:

An example of this would be someone in their 20s or 30s investing primarily in treasury securities, which are known for their safety but lower returns instead of investing in something like growth stocks, which can provide greater returns but come with more risk.

Sara Rathner:

Well, here's another example that I've seen with friends who were coming of age and coming into adulthood during the Great Recession around 2008, holding a lot of your money in cash, whether that's in a checking account or savings account, and investing very little or nothing at all. It keeps your money technically where you can see it, but inflation is eating up the value of your savings.

Sean Pyles:

Yeah, loss aversion also manifests when people hold on to poorly performing stocks for too long with the hope that they will eventually increase in value instead of just selling them.

Sara Rathner:

All right, listener, here's how you can manage your own loss aversion because we all have this. First of all, know that holding money in cash over the long term, I'm talking decades, isn't going to serve you. Yes, keep money in a savings account if you need it in the next five years, but for those longer term goals like retirement or really anything that's that far away, investing that money in a way that matches your timeframe and your risk tolerance can help you grow your wealth and stay ahead of inflation.

Sean Pyles:

Also, try to avoid pain if you can. Avoid inflicting pain upon yourself really. Next time the stock market inevitably takes a nosedive, just do yourself a favor and do not log into your retirement account.

Sara Rathner:

Yeah, putting your head in the sand can sometimes work in your favor.

Sean Pyles:

Yes. Occasionally, yes.

Sara Rathner:

Yes. Not always, but sometimes. Now, we are not investment advisors, but I'll say that buying individual stocks makes you more likely to hold onto the losers. You research the company and you feel that pride of ownership when you buy shares, so you don't want to give them up.

And for me at least, investing in funds like index funds, mutual funds or ETFs, which are exchange traded funds, kind of takes that ownership feeling away because I've bought into an amorphous blob of investments. So I really don't feel connected to any one particular company that's held as part of that fund.

Sean Pyles:

Also, understand that the stock market goes up and down. When the stock market is trending downward, which it will and may over an extended period of time, realize that this is the natural order of things, but that over the long run, the stock market has historically gone up. Just look at a chart of the stock market's performance over the past 10, 20, or even 30 years.

Sara Rathner:

All right, Sean, what's another bias people should be aware of?

Sean Pyles:

Framing, and I'm not talking about what you do at Michael's or another store like that. Framing is essentially about how information is presented to us, and it gets to the core of many behavioral finance biases that we all experience. The idea is that the same information presented in different ways can lead to different behaviors. For example, researchers found that consumers were more inclined to buy beef at the grocery store that sold as 75% lean beef instead of meat that was 25% fat.

It's the same product, but the way it's presented to us plays on our biases and can lead us to making different decisions. The idea of framing can be applied to all kinds of behavioral finance biases that people have, and this is because people are emotional, are easily influenced by other people and do not make decisions in a vacuum of rational thinking.

Sara Rathner:

So let's help people understand how they can be less susceptible to clever framing. First of all, a big thing here is just awareness. Assume that any information you encounter is being presented to you in a way to elicit a specific behavioral or emotional response.

Sean Pyles:

Whenever I encounter something that could be a piece of marketing, whether it's an ad from a financial services company or an influencer in my Instagram feed or even just a box of crackers at the grocery store, I ask a few questions, "What story are they trying to sell? What are they trying to get from me? And how does this benefit them?" It might be a little bit cynical, but it is effective.

Sara Rathner:

All right, let's turn to our third behavioral bias, the gambler's fallacy. I like that. That sounds really cool.

Sean Pyles:

What a great name, right?

Sara Rathner:

Yeah. Sounds like a band's name. So this is the mistaken belief that having a certain outcome like a stock price rising or winning a game of blackjack makes it more likely that it'll happen again.

Sean Pyles:

Gambler's fallacy is basically the opposite of the investing adage that past performance does not indicate future result. So Sara, what's a good example of this?

Sara Rathner:

Well, besides the whole blackjack thing, let's say you bought a stock of a company that after you were convinced it was going to shoot up over the coming quarter and then it actually did, which is awesome.

And you might then think that you now have a knack for choosing stocks and you put your money into another seemingly promising stock in the next quarter. But just because you gambled right one time doesn't mean you'll be right the next time. Investing this way can lead people to inaccurately assess risk and focus too much on short-term results rather than long-term gain. And we all know that investing is a long game.

Sean Pyles:

So here are a few things you can do to mitigate gambler's fallacy. First, recognize that any wins are pure luck. Just count your blessings and move on. And also remember that trying to time the market is a fool's errand.

Sara Rathner:

Well, listener, hopefully we've helped you understand a few behavioral biases that we all encounter. So we are all in the same boat. How to navigate them is really important. So we're heading into this episode's money question segment in a moment, but first, listener, ask yourself a simple question, where do you need help financially right now?

Sean Pyles:

Are you still debating whether to pay for your vacation with cash or points or maybe you're trying to figure out if pet insurance is really worth the cost? Whatever money question you have, we Nerds can help you answer it. So text us or leave a voicemail on the Nerd hotline at 901-730-6373. That's 901-730-NERD or email us a voice memo at [email protected].

Sara Rathner:

And while you're at it, answer our Nerdy question of the month, which is what's the best thing you spent money on this month? Why did you buy it and what did it bring into your life?

Sean Pyles:

Last week, Sara talked about how she paid for a plumber to perform an exorcism in her house after a truly horrific sewage incident, while I savored the joy of buying Beyonce's new CD to play on repeat in my car, which I have done. Both purchases improved our lives in very different ways, but to similar degrees, I would argue.

So now we want to hear what you spent money on, whether you did any shopping around or whether you have any tips for saving money. We might just share it on an upcoming episode. And in fact, here is a voicemail from a listener named Amy sharing the best thing that she spent money on this month.

Amy:

Hi, I actually don't have a NerdWallet question yet. I just wanted to let you know that something I'm very proud of spending this month is I spent $350 having a third opinion about my upcoming hip surgery. And I'm really glad I spent $300 seeing this really cool surgeon who basically said I was a perfect candidate for a less invasive surgery.

So basically I paid $300 for empowerment for my own body autonomy, and that's worth every penny to me. So I just wanted to tell people that, hey, sometimes it's really good to just take your health into your own hands and spend some money to get the outcome that you need. I'm not a wealthy person, but it's worth it to me. So anyway, thanks much. I really love your show. Keep doing the great work. Talk to you later. Bye.

Sean Pyles:

Amy, thank you so much for sharing your story with us. Amy's experience is a good reminder that no matter what you're in the market for, try to shop around if you can, might just save you money and in Amy's case, potentially some recovery time. So as we said before, listener, please share the best thing that you spent money on last month and let's talk about it.

Sara Rathner:

Now, let's get onto this episode's money question segment. Stay with us.

Sean Pyles:

We're back and answering your real world money questions to help you make smarter financial decisions. This episode's question comes from a listener's text message. Here it is. "What's up, Nerds? Can we talk about credit repair services and how useful they are? I became an EdTech founder and took out a few loans to fund my coding bootcamp and to support living expenses for the past two years and my credit has become shot. I'm now using a credit repair service, but I'm curious to see what's working for others or not. I appreciate this podcast more than words. Thanks."

Sara Rathner:

To help us answer this listener's question on this episode of the podcast, we are joined by NerdWallet Credit Writer Amanda Barroso. Amanda, welcome back to Smart Money.

Amanda Barroso:

It's always great to be back. Thanks for having me, Sean and Sara.

Sean Pyles:

So happy to have you on, Amanda. So let's first talk about what credit repair services actually offer. Can you give us a rundown?

Amanda Barroso:

I can. So a credit repair service is a company that says they'll help fix your credit reports and build your credit score by disputing any of the negative information or wrong information found on those credit reports. So for a fee, they will monitor your credit reports and make sure that the errors are removed and that they don't come back and reappear the next month.

Some of the companies might also just give you tips or recommendations for ways to boost your credit. The thing to note though is that credit repair services cannot remove negative items from your credit report that are accurate. So if you did miss that payment or the set of payments or your car was repossessed, there's nothing a credit repair service is going to be able to do for you on that front.

Sara Rathner:

There's one word that stood out for me that you said in your response, and that word is fee. It's not free to do this, to use these services, I should say. So how much are we talking? How much does this cost?

Amanda Barroso:

Credit repair services can cost around a hundred dollars a month, and it's likely going to take several months. And I should note there's no guarantee that the service will actually work. So the math is unclear, we should say, but around a hundred dollars a month.

Sean Pyles:

That's pretty expensive.

Sara Rathner:

Yeah.

Amanda Barroso:

Yeah.

Sara Rathner:

That's no joke as far as monthly expenses go.

Sean Pyles:

Yeah. And Amanda, I have to admit, when I hear about people using a credit repair service, I do cringe a little bit because people can do the work of a credit repair company themselves for free. But that said, there's clearly a market for these services. So who do you think credit repair is best for?

Amanda Barroso:

These are great points, Sean. And most of what these credit repair services offer are things that, like you said, people can do for free on their own, but it's overwhelming. And so we at NerdWallet, we understand that. But if you find that you really want to utilize a credit repair service to avoid the hassle of dealing with the credit bureaus, at NerdWallet, we urge you to be just super skeptical and cautious. And scams are really common kind of in this area.

And a lot of these companies' claims can be misleading. So remember, they can only help remove inaccurate or outdated information from your credit reports. Credit repair services cannot remove what's called derogatory marks. And this is sort of a fancy way to just say a missed payment, a bankruptcy, a repossession, collections, student loan default or a foreclosure.

So if they were not added erroneously or if they were not mistakes, these companies cannot remove those things from your credit report. In fact, these are some of the more serious marks against your credit and they can stay on your credit reports for seven to 10 years. So you just have to be really wary of companies that are making promises to remove these things from your credit reports before that time is up. That's a red flag that it could be a scam.

Sean Pyles:

Yeah. And thinking about our listener here, they said that they took out a few loans and now as a result of that, their credit isn't in great condition, and so that might mean they may have missed a payment. We don't know exactly what's going on and why their credit isn't in great condition currently, but if it's something that's accurate, like a missed payment, a credit repair company is not going to be able to remove that. Right?

Amanda Barroso:

Right. So I think that taking a real assessment of what's going on, diagnosing your credit, taking a look and seeing, okay, my credit score tanked around this time, let's look and really see what was going on with my financial behavior and see was this a mistake, a true mistake, and we can take steps to dispute that and get that removed ourselves for free, or was this just a financial misstep that we can recover from so long as we're being a little more mindful?

Sara Rathner:

So for anyone who's listening who is thinking, "I don't want to spend about a hundred dollars a month on this when I could do it myself," but the very idea of DIYing some of these financial tasks can be really, really intimidating, which is why so many of us do pay professional services to do them for us. But for anybody who is thinking, "You know what? I want to give this a try, I want to do this myself," what specific tasks are these credit repair companies doing on people's behalf and how can people instead do those tasks themselves?

Amanda Barroso:

I think the first thing that you can do is just getting your hands on a copy of your credit reports. At NerdWallet, we recommend using annualcreditreport.com. And the good news is that it's totally free to do this. So sit down one night, put the kids to bed, I don't know, make yourself a latte or whatever, and sit down on the couch and you want to go through line by line to see if you can find any errors there.

You want to be on the lookout for names and accounts that you don't recognize or payments that are marked as missed when you know that they weren't, inaccurate balances, anything like that, that can sort of be a red flag that there's a mistake going on. If you do find one of those errors and you have the proof that, "No, I actually did make that payment, and here's my statement to prove it," or "I don't know this person whose name appears here," you're going to want to file a dispute directly with the credit bureaus.

The three major credit bureaus are Equifax, Experian, and TransUnion. And at NerdWallet we have really detailed guidelines for how to file a dispute with each of those credit bureaus. You might find that the error appears only on one credit bureau’s report. Great. That's less work for you. Sometimes, and probably more likely, it might appear on all three. So you have to do your due diligence there. But you can dispute the issue online, over the phone, by mail. Online's typically the fastest. And the bureaus are required to respond to your dispute within 30 days. So that's a hundred bucks you save right there.

Sean Pyles:

So now let's talk about a few other ways that people can better their credit on their own, especially tips that do not require much effort. Because if you are considering credit repair, chances are that you want an easy solution to your credit woes. So Amanda, what do you think?

Amanda Barroso:

The credit world can feel a little bit like the man behind the curtain in The Wizard of Oz, but there are some really tried and true things that you can do and some best practices when it comes to building and maintaining a strong credit score. The first, most important thing that we want to reiterate is paying your bills on time and in full if you can. That's huge.

So payment history, I don't know if you knew this, payment history is the biggest factor used in calculating your credit score. So if you can't pay in full, try to make at least the minimum payments, you could even make smaller payments throughout the month. You don't even have to wait until that due date. It's really also important to keep that utilization low. We call it your credit utilization.

So we recommend using no more than 30% of that total credit available to you, but less than that is even better. So if you find yourself kind of creeping up to that threshold, take a step back, pause, pause that spending and focus on paying down debt to get back to that 30% or less. The cool thing is with the credit utilization, you can set balance alerts on some credit cards that will ping you if you're approaching that limit that you've set for yourself so you can really stay on top of things.

Sara Rathner:

Well, that's all great advice, and it definitely sounds like something someone can do if they're motivated to save some money and start tackling this issue by themselves. So Amanda, do you have any final words of credit wisdom for our listeners?

Amanda Barroso:

I think if you find yourself feeling overwhelmed by some of these derogatory or negative marks that are showing up in your credit reports and they're dragging down your score, consider looking into a credit counseling agency. And I say this, do not confuse these with the credit repair services.

These are actually nonprofit organizations that have counselors who will work one-on-one with you, assess your situation and come up with a unique personalized financial plan. Some of these services are free and you're going to want to find a credit counselor that's certified and accredited. And there's a host of those or you could check into the National Foundation for Credit Counseling. That might be a good place to start to find somebody who you feel like could help make a great plan for you.

Sean Pyles:

Great. Well, Amanda, thank you so much for coming on and talking with us.

Amanda Barroso:

Thanks for having me, y'all.

Sean Pyles:

And that's all we have for this episode. Listener, remember that we are here for you and your money questions. So turn to the Nerds and call or text us at 901-730-6373. That's 901-730-NERD. You can also email us at [email protected]. Visit nerdwallet.com/podcast for more info on this episode and remember to follow, rate and review us wherever you're getting this podcast.

Sara Rathner:

This episode was produced by Tess Vigeland and Sean. Sara Brink mixed our audio. Sheri Gordon helped with fact checking. And a big thank you to NerdWallet’s editors for all their help. And here's our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

Sean Pyles: