Avoiding unpleasant information is no way to treat your money
61% of Americans don't know the interest rate on their credit cards. This is likely due to the cognitive bias known as the ostrich effect.
Do you know the interest rate on your credit card?
This isn’t a silly question for many Americans: a 2018 poll discovered that only 39% of respondents knew what rate they were paying on their balance. That means over six out of every 10 American adults aren’t aware of their interest rate.
How is this possible?
Blame the ostrich effect.
The poker effect
Coined in 2006 by economists Dan Galai and Orly Sade, the ostrich effect is a cognitive bias that causes us to avoid unpleasant information. The researchers were investigating government t-bills and bank deposits in Israel when they conjured the image of an animal famous for burying its head in the sand—a metaphor they deemed worthy of people that avoid unfortunate financial information.
‘The ‘Ostrich Effect’ is defined as avoiding apparently risky financial situations by pretending they do not exist. This explanation suggests that since deposits are not marked to market, loss averse investors are able to ignore the market information, which suggests risk, even though the perceived risk is misleading. Thaler uses an example of a poker player who never counts his money while sitting at the table. By so doing, interim information regarding performance will not affect the gambler’s desire to continue.
Galai and Sade found that some people prefer to invest when risk is unreported. The price of a publicly traded t-bill is reported daily; bank deposits are not (nor are they marked to market). In general, deposits offer lower interest rates, especially during times of financial instability. Incredibly, many investors chose a lower-yield-producing investment because they didn’t have to look at it as much.
In fact, even though these two investments have similar risk profiles, Galai and Sade observed that in times of inflation (or other moments of uncertainty), investors are more willing to pay for “the bliss of ignorance.”
Three years later, researchers published similarly startling news: Scandinavian investors checked the value of their investments 50-80% less often during bad markets. They too appear to prefer the darkness of the hole than a potentially tumbling portfolio.
The distance between a poker table and stock portfolio is less than we assume.
A convergence of biases
The ostrich effect isn’t confined to the investment world. This cognitive bias extends well beyond our wallets—many of us try to avoid unpleasant information at any cost—but it has been observed in personal financial psychology as well.
No cognitive bias exists in a vacuum. They often work in conjunction with one another; when isolated, their power would be minimized. And so loss aversion helps to explain the peculiar power of the ostrich effect.
Sadly, humans aren’t long-term thinkers. The ostrich effect has been used to explain our inability to take proactive measures against climate change, for example. This is also why fewer Americans seem to be saving for retirement: a recent study found that at least half of adults don’t have enough saved for their golden years, with 16% having nothing at all stored away.
This is one of the more insidious aspects of the ostrich effect—we focus so much on short-term losses that we don’t consider the potential long-term gains those losses would produce. Storing away 15% of your paycheck might feel like too heavy a burden when there are so many home improvement projects waiting or vacations to take, even though such a deduction would serve you better in the long run.
Your perspective changes when considering how much farther that money will go after years (and decades) of compound interest. Sometimes “seize the day” is not an appropriate slogan when “remember the future” works more effectively.
Taking action
Because we’re inclined to seek out good news, we tend to pay more attention to information we desire (no matter how much social media has a negativity bias). Sure, we might click on anger-baiting headlines, but then a weird effect takes over: by reposting the tweet or hastily scribbling out an unformed reply, we think we’ve done something about the situation.
The illusion of action that social media provokes does not negate the ostrich effect. If anything, it strengthens it. Now that we’ve “responded” in some manner, we file it away instead of actually taking action.
Mad that big banks refuse to raise interest rates on savings accounts even though federal interest rates keep rising? A tweet tagging your bank will suffice! Only we all know that’s not the case. In reality, finding a financial app with a higher APY would be a better move for your bottom line.
Everyone will experience unpleasant information in their lifetime. Informed decisions occur when you take a holistic view of the situation. This requires paying attention to all details, including any info that you’ve avoided. To be fair, some situations call for a bit of ignorance—though this is rarely the case when it comes to your money.
Which is how the ostrich comes to lift up its head: by overcoming the impulse for inertia and making better decisions for its long-term interest. Just as the ostrich inspired the head burial, so too can it influence us when it stands up tall and looks out into the distance.