How Your Mindset Affects Your Finances
Money is an abstract and complex topic, especially since the endless stream of financial products such as mortgages, credit cards, and student loans. So how do you make the most of yours?
Answer: you probably can’t. At least not all the time, according to a new book by Dan Ariely and Jeff Kreisler, Dollars and Meaning: How We Misunderstand Money and How to Spend Smarter .
“It would be nice to think a lot about money if, by thinking more about it, we could make more informed decisions. But this is not so, ”the book says. “In truth, making bad money decisions is the hallmark of humanity. We are great at ruining our financial life. “
How to get a little easier with money? Admitting our flaws and the fact that we are acting irrationally is one way.
Relativity
According to Arieli and Kreisler, relativity is “one of the most powerful forces that make us evaluate value in ways that have little to do with real value.” For example, you may be more inclined to buy a shirt for $ 40 if the tag says it sells for the regular $ 60 than you would buy a shirt for the regular $ 40. In our opinion, the first shirt is more valuable than the second and has a better deal. But, of course, this is not entirely true. The “regular” presale price is no longer the real price, so should $ 60 really count?
The authors write that buying “bargains” like a shirt on sale for $ 40 makes us feel smart and makes decisions easier. But instead of evaluating what we think we are not spending – $ 60 in the shirt example – we must consider the absolute value of what we are still spending.
Another classic example is car dealership incremental sales. If you’re spending tens of thousands on a new car, you might not be bothered by spending another $ 2,000 on leather seats. In relation to the price of the car, that upgrade doesn’t seem like a lot of money (especially when you add in funding).
This is because we often think about the percentage of expenses rather than the actual amount. This is why you can spend an extra $ 2k on these leather seats, but not $ 4 for a cup of coffee on the way to work. Compared to $ 0, that’s a lot of money.
Psychological accounting
Mental accounting is how we share our expenses. Although in theory one dollar is worth the same as any other dollar, we do not perceive it that way, depending on the mental category we assigned to it, or how we feel it.
For example, you could set spending categories with strict monthly requirements: $ 250 for loan payments, $ 200 for food, $ 100 for vacation bill, $ 100 for entertainment, and $ 50 for utilities like the envelope system. Once you run out of money for one category, you stop spending, although it would be easy to “move” money from another category. After all, this is all your money.
This is not necessarily a problem; in fact, it can be a very useful shortcut. This is because, as the authors write, it allows us to leave out every opportunity cost every time we buy something. Instead of thinking of avocado toast as money that you won’t have for a future mortgage, you can think of it as money that you won’t have for your other food purchases this week. This is irrational, but it will save you from madness.
But, of course, we do not stop there. While we categorize ourselves, we often use flexible mental accounting to fool ourselves into our spending so we don’t feel so bad. We change our own rules with suspicious excuses. For example, we know we shouldn’t eat outside the home, but we only do it once because we tell ourselves we deserve it after a tough week, and maybe this $ 60 dinner comes from our “fun” fund, and not from our food fund. …
Then how we think about money from various sources called emotional accounting. We can spend our wages on “responsible” things like rent and food, while Mom’s Christmas money is spent on “fun” things like a new TV. It’s the same with job bonuses or tax refunds – it all seems like “extra” money that we don’t have to be responsible for.
Anchor
Anchoring occurs, the authors write, when we allow irrelevant information to influence our decision making, and then use that irrelevant starting point “as a basis for future decisions from that point on.”
For example, you may not know how to price a car until you see the manufacturer’s suggested retail price. This gives you the starting digit, whether the value is true or not.
One way to create an anchor is by trusting ourselves — our judgment of the value of things — much more than we should. We base current and future money decisions on past ones. “We believe that we have repeatedly made a specific value decision, and we believe that it was the right one,” the authors write:
Once we pay $ 4 for a latte and $ 50 for an oil change, we have a better chance of doing so in the future because we have made this decision before, we remember it and are partial to our own decisions, even if it means paying more. than we need. Even if there is a place offering free coffee while we wait for a $ 25 oil change.
Another example of pegging that can affect your financial life: salary negotiations. In negotiations, the first number thrown out is powerful – there are many tips and tricks that advise you not to give the first number if you underestimate yourself (especially for women), or give a deliberately inflated number in front of your potential employer. makes it so that you are in control of the process.
But anchoring doesn’t have a pronounced effect when you know a little about what you are buying. For example, a real estate expert is less likely to be affected by the listing price of a home than someone who is not. Or we may trust ourselves less.
What can you do about it
Arieli and Kreisler’s book say self-control is one of the keys to using our finances, and they recognize that this concept is easier to talk about than to implement.
“Responsible” personal financial management aims to ensure that we can succeed in the future. And that future self can often feel like a stranger – which is why it is easier to spend on something now or not participate in your company’s 401 (k) program.
To make you feel more like yourself in the future, you need to make this person “specific, vivid and detailed.” One way is to talk to yourself in the future. Another option is to choose a specific retirement date (if you find it difficult to achieve that goal) rather than the amount of time. Let’s say January 12, 2058, not “in 40 years.” The authors also suggest “getting to know” a computerized version of the old self as a way to develop empathy.
This may sound a little odd, but they suggest other ways as well. For example, automation, if you have enough funds to do it. Vina works too (the book cites research by Dilip Soman and Amar Chim of the Rotman School of Management, which showed that people spend less when their children’s names are written on envelopes of money because they feel bad about it).
You can also try reward replacement . Instead of forcing yourself to think about the future all the time, think of some small reward you could get now if you complete the tasks you need. For instance,
Some states do just that by offering “lotteries” for people who deposit money in savings accounts. Each deposit is accompanied by a ticket that offers a small change in the form of winning an additional amount of money. These lottery-based savings plans work.
For you, this could be a movie of paying credit card debt or something similar.
Obviously, this tactic will not solve all your problems – a very large chunk of money is influenced not only by your personal behavior, but also by a system designed to be opaque and confusing in many situations. However, this is a good lesson in how we can begin to train ourselves to think smarter when it comes to our money.