Avoid Magical Thinking in Personal Finances and Make Better Plans
Like most people, I enjoy daydreaming about the next stage in my life when all my financial worries are resolved and I can do whatever I want with my time. I spend my days hiking, volunteering, writing a novel, traveling a little with my wife, visiting my kids in college or in their adult life, organizing social events, playing a lot of board games with friends. , reading … things that I would like to do in retirement.
This post was originally published on The Simple Dollar .
This is a very joyful picture for me, but there is one big problem with it. This dream completely obscures what I needed to do to achieve this. It leaves out the many, many years of work and savings it will take to achieve that goal.
Without a ton of hard work, this beautiful vision is unrealistic. This is magical thinking.
So what is magical thinking? I like Wikipedia’s explanation :
Magical thinking is the ascription of a causal or synchronous relationship between actions and events that does not seem to be justified by reason and observation. […] Magical thinking can make people believe that their thoughts by themselves can cause effects in the world, or that thinking something corresponds to it. It is a type of causal reasoning or causal error that looks for meaningful relationships of grouped phenomena (coincidences) between actions and events.
A great example of magical thinking when it comes to money is lottery tickets. People who play the lottery regularly prefer to choose their own numbers, even if the outcome of the lottery is random. People even buy and sell books on the topic, books that are nothing more than an indication of the boundaries in which lottery numbers are played, and then using a mixture of bad math and magical thinking to come up with useless “practices” for picking lottery numbers. …
While this is a funny example, magical thinking continually shows up in people’s financial planning, causing them to make huge, stupid mistakes.
For example, far more people believe they will receive retirement benefits than people who actually receive retirement benefits at work. According to this study by the Employee Benefit Research Institute , “Only 40 percent of workers indicate that they or their spouse currently have a defined benefit plan, but 61 percent say they expect to receive income from such a plan when they retire.” Even stranger, 40% of people who have not saved anything for retirement believe they already have sufficient retirement savings.
Magical thinking arises in personal finances every time we overestimate the likelihood of a certain positive outcome far exceeding what is real in our current life, and becomes dangerous when we act based on that overestimation. In the retirement example above, this mindset can easily cause people not to invest in a Roth IRA or 401 (k) plan when they should, but they choose not to because of magical thinking and an overly positive picture as a result. the future.
Examples of magical thinking and money
Here are some compelling examples of how people use “magical thinking” to make huge financial mistakes.
Overly optimistic “me of the future”
Many, many people fall into the financial trap of believing that their “future self” will pay for their current financial mistakes. For example, many people on the lower rungs of the employment ladder will spend more than their paycheck and build up debt because they believe that their future self – who will climb the ladder and make more money – will pay. costs. …
Why not take a trip now if that magical “me from the future” pays the bill?
In our non-magical reality, while there is a chance that your future self will climb the ladder and earn more, there is also a good chance that your future self will not climb at all, or that your future self might become frustrated and switch careers entirely.
If you make your financial plans today based on a highly overestimated likelihood of earning a higher salary in the future, you are falling prey to magical thinking. You have a very good chance to dig yourself a deep financial hole, from which you will need a very long time if you do not fall into this optimistic future.
Prosperity Gospel
Many people tend to believe that if they seek direct intervention from a higher power, then a higher power will enter their lives and create a better result for them.
This type of magical thinking emphasizes things like the prosperity gospel , which I described in a previous article :
Simply put, the prosperity gospel focuses on the idea that God provides material prosperity to those in whom he favors. The idea is twofold: financially successful people achieve such success because they are approved by God, and at the same time, people who are favored by God will ultimately achieve material success. In other words, piety leads to material prosperity.
This approach turns faith into a transaction-based system. If I act in a certain godly way (usually as directed by someone who preaches the prosperity gospel), then God will reward me with material goods.
While I think prayer has many benefits, it can follow a similar logic. If I ask for divine intervention in this event, then there will be a high probability that I desire from this event. Again, this turns belief into a transaction-based system.
The problem with faith as a transactional system is that it doesn’t really work that way. For example, philanthropy is highest among low-income households and least among wealthy households, which is the exact opposite of what you would expect if the prosperity gospel were true.
I don’t know of any reasonable theology in which you could treat God as your personal ATM machine for what you want. In contrast, prayer and charity tend to have the best effect in terms of being tools to help you grow as a person in your inner world , rather than as a source of physical reward.
“My ship will enter”
Many people believe that some great unknown future event will solve all their worldly problems. This vision takes many different forms: a rich ancestor leaving a little money behind is one taste, and winning the lottery is a different taste. I once worked with a man who essentially thought he would end up being treated unfairly in the workplace and then sue the workplace for a lot of money. This person claimed to have documented all possible minor and negative events in the workplace. (Needless to say, I have tried my best to avoid interacting with this person in the workplace.)
The truth is, while random events do happen and bring undeserved wealth to people’s lives, the likelihood of such events is incredibly small. There are very, very few lottery winners who have changed lives. There are very, very few real-life examples of massive unexpected inheritance. It’s just that things like that don’t happen very often. People constantly overestimate their likelihood, and people sometimes even plan their lives with the assumption that this will happen, which is a large part of the reason most Americans don’t save for retirement at all. They believe that their ship will come.
How to avoid magical thinking and make better plans
The big picture is clear: magical thinking engenders unfounded optimism about the future and thus causes people to make the wrong choices today because of this unfounded optimism. While it is okay to have a positive vision of the future, it is incredibly dangerous to take action in your life in the belief that this positive vision is a foregone conclusion.
How can you avoid magical thinking in your life? Here are five really helpful strategies.
Strategy # 1 – Assume that the probability of occurrence of unlikely positive events is zero
If you find yourself dreaming of your “Ship is Coming” – you win the lottery or receive a large batch of cash from an unexpected source or something akin to that, never, never assume that there is any chance that this will happen … Consider the chances of this event happening to be zero , even if the odds are better than zero.
Every time you start treating an extremely unlikely event as having a higher chance of coming than it actually is, you start making the wrong life choices. If you believe that a large wad of money is about to fall into your lap without any direct evidence of it, and then start spending accordingly, you are digging yourself a hole that you are unlikely to dig yourself out of.
Money will not fall from the sky and fall on your lap. Don’t act like this is about to happen.
Strategy # 2 – Assume Your Future Self Will Be Worse Than You Are Now
When it comes to financial plans for the future, you should never assume that you will earn more in the future. Instead, you should assume the opposite – you will earn less in the future.
Why would you do that? If you are acting on the assumption that your future self will earn less , you are not going to voluntarily bury yourself in a financial hole that will be difficult to get out of. You are not going to buy a car with huge payouts. You are not going to burden yourself with gigantic house payments. You will avoid credit card debt.
So, let’s say you actually make more money in the future. Wonderful! Now you can really afford these nicer things without digging yourself a giant hole! Take action!
Most of the time, however, you will not earn significantly more in the future, and if you decide to go into debt now, your future self will dig up that debt in the future at no additional cost. income. In other words, your future life will be pretty dire even if you keep your current income.
If your income is dropping due to job loss or something like that? It will be very, very bad.
When you are trying to decide whether to take on debt or other large expenses, ask yourself what will happen if your salary stays the same for the next, say, ten years. What happens if you lose your job and have to go for one that pays 25% less. What would your life look like in these scenarios when you are burdened with a lot of debt? If it makes life very miserable and very stressful, then don’t take on that debt today. Run the other way instead.
Strategy # 3 – If you want something in your future, take action and accept the fact that it may not happen.
If you don’t work for something, it will never be given to you. The awards aren’t just given away for free. This is a lesson that people should theoretically learn in childhood, but adults often act as if they should be rewarded for just being there.
The truth is, if you want this promotion, you have to work for it. If you want to have a successful small business, you need to work on it. If you want a promotion, you need to work on it. They won’t give it to you. You must show that the extra money you are getting is justified, otherwise other people will justify NOT giving it to you.
You think you are expecting a promotion at work. Why? Are you doing something outstanding that earns you higher wages than other people doing your job? If so, does that amount to results that your boss can actually see in some way? Is this true all the time, day in and day out?
You think you are expecting a promotion. Why? Are you doing something that demonstrates that you have the skills, communication skills, and leadership qualities needed to move to the next rung of the ladder? If you think so, are you doing something that demonstrates these skills to your boss in the way he or she really sees? Do you do it all the time?
You think you are ready to find a better job. Why? Does your resume really include all the skills that employers look for in your position? Do you have additional things out there that complement your case and really demonstrate how you have all these skills and can put them into practice? Do you have any reliable recommendations? Do you have current skills and some evidence of these skills? Are you selling these things to potential employers?
You think you are ready to start your own business. Why? What does your business plan look like? What evidence do you have that your business will resonate with the community it serves? Will you be able or will you make the effort to make this business a success?
What is common here? Hard work. When you want to get ahead in life, it takes work. Even if you think it’s all about the people you know — which I don’t believe at all, but I believe it helps a little — you still need to put in a lot of effort to build a good professional network. If you want something, you have to work on it. It will never, never be passed on to you.
Strategy # 4 – Save for retirement. If you are already saving, save more
You can never accumulate “enough” for retirement. Even if you somehow manage to hit the magic number that will cover everything you ever want in retirement, more money simply means more security at retirement or the ability to retire earlier, both of which are positives.
You can never invest enough in your Roth IRA. You can never put enough in your 401 (k). If you ever believe that you will have enough money for retirement, the truth is that you will not. If you’ve ever wondered if you should invest more in retirement savings, the answer is that you should (unless you overlook the high interest rates – anything above about 6% – of debt).
Many resist this for two reasons. One is purely magical thinking: their ship will call before retirement, so they won’t have to worry about it. It won’t happen.
Second, they assume they will lose a lot of their joy in life if they increase their retirement savings by 1% or 2% of their salary. This will not happen either. The truth is, the things you lose by investing more are the least important 1% or 2% of your spending. These are the stupidest and most overlooked elements of your spending. It’s a convenience store item that you drink and forget. This is an album that you bought from the iTunes store, listened to once and forgot. It’s not really about things.
When you combine magical thinking with unrealistic fears about your lifestyle, it becomes abundantly clear why people talk themselves out of retirement savings. Do not. Both elements are myths. You must save as much as possible.
Strategy # 5 – Establishing an Emergency Fund
This goes back to the rosy vision of the future that many people hold. When most people think about their future, especially the near future, they tend to think mostly about the positive. If their car doesn’t make a lot of noise, they don’t think about it breaking down. They don’t think about losing their job (unless paranoia is rampant at work). They don’t think about the child being sick or about the cost of emergency care for the child. They don’t think about losing their wallet or stealing their credit card numbers.
The truth is, these things happen. Thinking about the near future when nothing like this is happening is a taste of magical thinking, and if you act in full accordance with this kind of magical thinking, you will find yourself in a financial predicament, faced with paying bills and (probably) with debt on credit. maps. that you just don’t want to face.
The best solution in these situations is to have cash in case something goes wrong. Money is king. Cash solves problems that credit cards fail. You need cash for a variety of emergencies that it can give you.
How do you make sure you always have money for an emergency? The answer, of course, is the emergency fund. You can create one by opening a savings account with your local bank and setting up an automatic transfer to transfer a small amount of money once a week from your checking account – just $ 10 or $ 20 will work if you are low on money. If you automatically transfer $ 20 per week, you will be investing over $ 1000 per year in your emergency fund!
Never, ever, turn off automatic translation unless a change in income forces you to do so. Even if you have a lot in your emergency fund, ignore it. Wait until the emergency is triggered. You will be so glad you have this money.
Final thoughts
Magical thinking is a huge financial trap. This forces you to ignore future risks. This forces you to avoid the necessary financial steps to protect your future. It forces you to make huge spending mistakes here and now, from which you will suffer for years.
Do your best to drop magical thinking and stick to reality. Your real, real life will be much better.
Good luck!
Personal Finance and Magic Thinking | Simple dollar