Understanding Behavioural Biases in Teen Financial Decisions and Strategies for Improvement

Navigating financial choices can be especially tough for teenagers, who often lack experience, impulse control, and at the same time face numerous choices -- probably more choice than available historically. Teenage financial decisions are frequently swayed by behavioral biases, leading to less-than-ideal outcomes. By understanding these biases and using targeted strategies, we can help teens make smarter financial decisions that will benefit them long into adulthood.

We spoke with Daivd Lincoln, Co-Founder and Partner at WISE, an exerienced advisor to wealth managers and financial executive who has written extensively on a broad range of wealth management topics, to get his views on themes of challenges he thinks teens would face, and how it may affect their financial health as adults. While David's area of expertise relates to adults, we asked him to consider how laying good foundations as teens can lead to better financial outcomes for adults.

Common Behavioural Biases in Teen Financial Decisions

David pointed out a number of behavioural biases that teens may have. One of the main biases impacting teenagers is overconfidence. Young individuals often overestimate their understanding of finance and their ability to manage money. For instance, a survey conducted by Junior Achievement found that 56% of teens feel confident in their financial knowledge, but only 24% can correctly answer basic financial literacy questions. This overconfidence can lead to risky choices, like ignoring the importance of paying down high-interest debt or investing without proper research.

Overconfidence may mean that teens may develop the belief that they can make important financial decisions without professional help, or proper research. This could come in the form of racking up high interest credit card debt, rather than paying it off and potentially investing in something that could yield a return. Or taking on too much student loan debt, without fully understanding the long term effects or if their future earnings justify taking on so much debt. Such decisions can seriously limit their potential for wealth accumulation over time.

David highlights another common behavioral bias is misperception of risk. Many teens underestimate the dangers associated with borrowing money or the unpredictability of investing. Data from the National Endowment for Financial Education shows that 77% of teens don't understand how debt can impact their future credit scores. Consequently, a teen might rush into buying trendy but speculative investments, like cryptocurrencies or even individual stocks rather than index investing, without understanding the risks involved. Data shows that Bitcoin and individual stock voliatility is significantly higher than a more diversified investment approach.

There has been data suggesting people regularly prioritise repyaing low interest mortgage payments -- a conservative move -- over diversified investing in the stock marketing, which would result in higher returns and overall better outcomes for people. What is the psychology behind this, and do we see the same types of behaviours with teens?

One of the behavioural biases that David highlighted was inertia, where people put off starting retirement savings because there is a perceived level of difficulty. It may be that this is characterised as 'laziness', something teens may be unfairly accused of. Perhaps this isn't laziness, but a behavioural bias of inertia, or even fear, and we should support young peope more through education to reduce the perceived level of difficult.

How Heuristics Shape Teens' Financial Decisions

David pointed out that teens often rely on heuristics, or mental shortcuts, to simplify complex financial decisions. One commonly referenced heuristic is the "one over N" rule, which suggests that individuals should evenly distribute their investments across all available options. While this might seem logical, it can lead to poor outcomes if it ignores factors like risk tolerance.

Another common trap for teens is their tendency to prefer immediate gratification over long-term benefits. This behavior can fuel impulsive purchases, such as spending thousands on the latest smartphones or gaming consoles instead of saving for education or future needs. In fact, studies reveal that delaying gratification can lead to better financial health, with savers often achieving 30% more wealth over a lifetime compared to those who spend impulsively.

Perhaps one of teens' biggest financial challenges: undrestanding the importance of saving for the future

Practical Strategies for Parents and Educators

Parents and educators can utilise effective strategies to help teens overcome behavioral biases in their financial decisions:

1. Educate About Financial Literacy: Provide relevant resources and engage in discussions about budgeting, investing, and compound interest

   
   

2. Model Good Financial Behavior: Show teens how to manage money effectively in everyday life, demonstrating how to save, budget, and make wise spending choices

   
   

3. Encourage Open Discussions: Create a comfortable environment for discussing financial thoughts and decisions, fostering critical thinking about money

   
   

4. Use Real-Life Examples: Share stories that highlight the outcomes of poor financial decisions versus the benefits of solid financial practices

   
   

5. Promote Goal Setting: Help teens establish clear financial goals, whether for immediate purchases or long-term savings, reinforcing the value of working towards these objectives

   
   

Building a Brighter Financial Future

By undertanding some of the psychological elements driving teen behaviour, we can encourage teens to take a long-term view and focusing on sound financial habits, and help them develop a secure better financial futures. Encouraging critical thinking around financial decisions will not only enhance their understanding now but also set them on the path to lifelong well-being.