Newton’s First Law of Motion states that a body at rest will remain at rest unless an outside force acts on it, and a body in motion at a constant velocity will remain in motion unless acted upon by an outside force. This is status quo bias. But let’s dig a bit deeper into why it is so dang hard to change.
Four Forces of Status Quo Bias
Four main forces make staying with the status quo your default choice They are Confirmation Bias, Endowment Effect, Loss Aversion, and Sunk Costs Effect. Let’s talk about each one and how they affect your decisions making.
Confirmation bias is the tendency to only believe and find data that supports your current position and disregard opposing data as false or wrong. Supposed you are deciding on a new washing machine because your current one is 20 years old. You read about all the new types of washers but also find reviews that say the new washers are not built the way they used to and break down faster or older washers can have 30-40 year lifespans vs the 10-year lifespans of the new washers. These reviews and comments confirm you thought that maybe keeping the old washer, which uses 5X the amount of water and detergent and doesn’t seem to get clothes as clean as before, might be a better idea. You disregard other reviews that say the new washers use less energy, water, and detergent and sound so quiet. You start thinking those were paid reviews from people who never owned a washer. You are confirming what you already think, making you feel better about your decision to keep your old washer.
The endowment effect, which some call the primary status quo bias force, is about how people demand more to sell an object than the cost of buying it. In other words, something you own is much more valuable to you than something you buy. We have seen this effect in selling a car or a house and thinking your car or house is worth more than the market rate. This also is an issue with investments you own. Suppose you have owned Google stock for years and watched it go up, but now you are afraid the company is too big and has nowhere else to grow ad revenue. This start-up is now an established big company. You are looking at other startups that may be a good investment but feel like Google has done well for you, so why give it up? You feel the endowment effect because you have owned Google and have a “past history” with the stock; you feel an emotional connection to the stock even though Google stock has no feelings. If you forgot the past and look at Google vs. the other startup you want to invest in, you might move your money to the other startups.
Loss Aversion is the heart of many emotional biases we talk about. We all want to avoid any loss and have to feel the emotional pain of the loss. For status quo bias, you are afraid of moving away from your current state and taking a risk that might lead to a loss, so you do nothing, which you believe ensures no loss. Continuing on the Google example above. If you take the $1000 you have invested in Google and move it to a health care startup, for example, you are definitely taking a risk, but you took a risk on Google way back when right. But you feel safer not to risk your $1000, so you stay put on changing this investment.
We talked about the sunk cost effect in a previous blog, so I will not rehash it all here. Basically, sunk cost effect considers past non-recoverable costs, time, or resources in deciding the future. Because of the sunk costs you feel you have put into an investment, and you see any change as losing that sunk costs, you feel you want to stay put and not change.
Tips to Overcome Status Quo Bias
1. Reframe
Reframe your current position or status quo as a loss. From prospect theory, losses hurt much more than gains, so if you frame your starting point not at zero but at a loss position, you better see all new investments as a possible gain. Another way to describe this is that if you stay the course, your future profit may be less than other investment choices.
2. Forget the Past
Your investments have no feelings, so why do you have any emotional attachment to your investments. What happened in the past with your current investment has no bearing on what will happen in the future. You have seen this statement, “Past performance does not guarantee future results.” Believe it. Forget what the investment has done for you in the past. If you are investing now, what would you invest in to maximize your profits?
3. Limit Options
Decision paralysis happens to everyone when they are faced with too many choices. Many would choose not to make a choice and stick with the status quo. There are 2500 stocks on the Nasdaq and 2800 stocks on the New York Stock Exchange. That is a huge amount of stocks you can invest in, not to mention bonds, mutual funds, ETF, etc. Narrow your options to help make a decision with your current status quo investment as one choice. Narrow your choices by type of investment (stocks, bonds, mutual funds, ETFs, CDs), type of stock (technology, internet, healthcare, consumer goods, crypto trading, etc.), region (U.S. only, Europe, APAC, Emerging markets) or bet on the entire U.S. Stock market with and ETF or mutual fund. The smaller the number of choices, the easier to compare and make decisions.
4. Find Proof
Lastly, do your research on the limited options you filtered down. Find proof for staying with your current status quo investment or going to another investment, but watch out for your confirmation biases. Choose metrics to compare (EPS, P/E ratio, debt to equity, expense ratio, etc), so you are removing bias and looking at data. When I invest in ETFs, I narrow in on a type of EFT and then on the expense ratio. Why should I pay for the same basket of stocks that are unmanaged and pay a high annual fee?
Overcoming status quo bias is very difficult emotionally. Try to be rational and use data and metrics to choose your future investment better. Just because a stock did well for you in the past does not mean it is the right stock for you now.
Another thing to consider is your current financial situation. Maybe you just had a baby, and your high-risk investments seem too risky for family financials, but there may be other investments that are less risky. Every time you review your investment portfolio, and don’t do it too often, think about what you would do NOW if you started with only cash to invest.
Behavioral Investing and Finance 