Every year, thousands of Canadians experience a financial fraud or scam. In fact, 2023 saw $554 million lost in frauds reported to the Canadian Anti-Fraud Centre. Fraudsters use clever tricks and technology to take advantage of people, and they exploit human nature.
When people make decisions, they often rely on intuitive judgments. In complex financial situations, people may use these judgments to simplify decision-making process. Unfortunately, this can lead to unwanted outcomes, like having money taken in an investment scam. By understanding our behaviour and decision-making processes, we can better protect ourselves from investment frauds and scams.
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What are frauds and scams?
Financial frauds and scams happen when people intentionally mislead others in order to take their money. Fraudsters use a combination of tactics to convince people to provide their money or personal information.
While more than half a billion dollars was reported lost to fraud in Canada, actual losses are much higher. That’s because only about 5 to 10% of frauds are reported. It’s important for people to report frauds and scams when they witness or experience them. This can help create more awareness and prevent future cases.
Fraudsters are skilled at taking advantage of blind spots or flaws in our decision making, known as behavioural biases. These biases can make us more likely to fall for frauds and scams, but they can also be managed to prevent this from happening in the first place.
Anyone can become a victim of fraud. Learn more about the different types of fraud and the ways a fraudster might approach you.
How do fraudsters exploit behavioural biases?
Fraudsters take advantage of blind spots in our decision-making known as behavioural biases. They exploit these biases in order to manipulate people and take their money. Here are five common biases that fraudsters exploit:
- Optimism bias
Optimism bias is a tendency to overestimate the probability of positive events and underestimate the probability of negative events.
This bias may lead you to overestimate the trustworthiness or legitimacy of potential fraudsters and underestimate the likelihood of being offered fraudulent investments. This bias is related to all types of frauds and scams as people overestimate the credibility of the promises being made by those promoting them.
2. Halo effect
The halo effect takes place when positive impressions of a person in one area positively influence our impressions of that person in another area. For example, people who are judged to be physically attractive are more likely to be considered trustworthy, even though one does not imply the other.
The halo effect is exploited in affinity fraud. For example, affinity fraud often takes place when fraudsters infiltrate a volunteer group or religious community to befriend the members. The fraudster’s friendliness causes victims to overestimate their trustworthiness – due to the halo effect.
3. Present bias
Present bias is the tendency for people to maximize pleasure and minimize pain in the near-term, often at the expense of the long-term.
A notable characteristic of many investment scams, particularly crypto scams, is that they promise massive returns in a short period of time. Fraudsters tout the high returns of their investment opportunity, insisting that investors can make a lot of money very quickly. This takes advantage of present bias, as people are drawn to the promise of making high sums of money as quickly as possible.
4. Regret aversion
Regret aversion takes place when people fear that they will end up regretting whatever decision they make in a situation. Regret aversion pushes people to think about the worst-case scenario and how much regret they would feel in that scenario (rather than thinking of all potential outcomes).
Regret aversion contributes to boiler room scams. Fraudsters use high pressure sales tactics to convince you to invest in a seemingly amazing opportunity. Since the promised returns are so high, victims focus on the regret they will feel if they don’t invest, and ignore the possibility of losing their investment.
5. Representativeness heuristic
Representativeness takes place when people judge the likelihood of an event based on how similar it is to another event. For example, suppose a coin is flipped and lands on heads nine times in a row. We feel certain that the tenth flip will be tails, but the probability is still 50/50.
Representativeness is exploited in pump and dump scams. Fraudsters artificially drive up the price of a stock over a short period of time. Victims feel that a further increase in the stock price promised by fraudsters is bound to happen again, even though these increases are very rare.
Behavioural biases are a part of being human. Fraudsters take advantage of them in order to take money from unsuspecting people. Being aware of these biases is an important step in recognizing potential frauds and scams when they come your way.
Our individual behaviours are prone to bias. That can make financial decisions challenging. Try our behavioural bias checker to understand how biases might be affecting your financial decision making.
How can you protect yourself from fraud and scams?
Recognizing and identifying financial frauds and scams is the key step in protecting yourself from them. Here are a few tactics you can use to help you avoid financial frauds and scams.
- Get a second opinion – If an investment opportunity seems too good to be true, then this is a red flag. Before giving up any money or personal information, get a second opinion from a reputable and trusted source, such as a registered financial advisor.
- Check registration – Anyone selling investments must be registered with their provincial securities regulator. You should check the registration of anyone offering investment opportunities, including trendy crypto platforms.
- Take the time you need – It’s good to be suspicious of limited-time offers and high pressure sales tactics. If you’re considering an investment, take some time to think about it. This will activate your more critical thinking, and help you avoid making an impulsive decision.
Many people who experience financial loss through frauds and scams never thought it would happen to them. These tactics can help prevent you from losing money to empty promises.
Watch this video to learn about the four signs of investment fraud. Learn more about other behavioural biases which might be impacting your financial decisions in ways you may not realize.
Summary
Fraudsters take advantage of human nature to take peoples’ money and personal information. Here’s how it works:
- Behavioural biases are blind spots or flaws in our decision-making and behaviour. They make us more susceptible to financial frauds and scams.
- Fraudsters exploit behavioural biases in order to promote their scam and convince people into giving up their money and personal information.
- Some common behavioural biases that fraudsters take advantage of include present bias, optimism bias, regret aversion, halo effect, and representativeness heuristic.
- You can protect yourself from financial frauds and scams by getting a second opinion, checking registration, and taking some time to consider the legitimacy of the pitch.
