Money is more about mind than it is about math. Our financial decisions are often based on psychology and emotion rather than on pure numbers. Nearly everyone understands intellectually that credit card debt is bad, for example, but for millions of people, this understanding isn’t enough.
A newish group of researchers dubbed behavioral economists have been exploring the gulf between financially optimal behavior and the things people actually do. One reason, said economist Dan Ariely in yesterday’s London Guardian, is sheer habit:
Orthodox economists don’t recognize habits. “They assume ordinary people do a constant cost-benefit analysis on everything they do. But actually, after you reach a decision, you say, ‘That’s the end of it!’— and just continue.” Which is one reason why more competitors entering an industry does not immediately prompt customers to [switch brands].
The article describes other ways in which psychology plays a role in our financial decisions:
- Increased choice makes us less able to choose. This is true in the cereal aisle, but it’s also true when shopping for cars, or for a mortgage. It’s easier to evaluate three products than it is to evaluate thirty. Sometimes choice isn’t a good thing.
- Our habits affect our habits. We are creatures of inertia. If we’re accustomed to buying a certain type or brand of product, we’ll continue to buy it even if there might be a better choice. The “known” is familiar and comfortable.
- We don’t actually know the value of the things we buy. Rather than evaluate how much a new television is worth to us, for example, we allow ourselves to be guided by manufacturer’s pricing and sale information. If we buy a new TV for $1,000 — marked down from $1,300! — we tell ourselves we scored a deal, even if that television may not give us $1,000 in value. (This is why Your Money or Your Life‘s concept of trading life energy for Stuff is so eye-opening to many people.)
- People cannot always figure out what is in their best interest. “Money and risk are abstract, complex things,” Ariely says. Because it’s difficult to know which option is best, retailers can nudge people into purchases. (And perhaps the reverse is possible — maybe people can also be nudged into making smart financial decisions, like opening retirement accounts or paying off debt.)
- We’re swayed by things that do not matter. The article describes how Ariely — a trained economist — spent more on a car just because it came with free oil changes, a decision he regrets. Recently at All Financial Matters, JLP told the story of a woman who traded in her gas-guzzler for that gets better mileage. JLP ran the numbers, though, and concluded that this was a decision that only made sense on an emotional level.
- We tend to throw good money after bad. Though it’s not mentioned in this article, the sunk-cost fallacy is another common mental mistake. Just because you’ve spent money on something doesn’t mean you should continue to spend money on it. It doesn’t even mean you should keep the item. What matters is the item’s future value to you, not how much you’ve spent on it.
If you’re in debt or have spending problems, take time to examine your habits. Do you let emotion affect your financial decisions? Do you buy things you soon regret? Do you tend to make risky investments? If so, consider researching behavioral economics. Understanding why you think the way you do is an important step to changing your habits.
I used to succumb to many of these mindsets, too; I’m sure that I often still do. Lately however, I’ve found myself with a different sort of problem: It’s almost as if I’m scared to spend money. I’ve finally reached a point in my life where I could afford to allow myself small indulgences, but I’m afraid to do so. Am I becoming a miser? I wonder what the behavioral economists would say.
Here are some related stories from the archives:
- Why We Buy: The science of shopping (see also How to spend less: Lessons from Why We Buy)
- Common money mistakes and how to correct them
- How shopping momentum leads to more shopping
If you’d like to learn more about behavioral economics, I highly recommend Why Smart People Make Big Money Mistakes (and How to Correct Them) by Gary Belsky and Thomas Gilovich [my review]. It’s an excellent book, and very readable. Borrow it from your public library.
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This article is about Choices, Psychology
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Don’t become a miser. You must maintain a balance between saving for the future and enjoying life right now. Because right now is the only moment you are guaranteed to experience. The problem being most people can’t plan for all the additional moments they are likely to have years ahead.
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I think your reaction to not spend money is simply a delayed reaction to the realization of just what your spending was doing in the first place. Your brain’s still trying to wrap around new concepts (aka, break the habits).
And if you think people find habits of spending money hard to break, or find habits aren’t economically efficient, boy, let me tell you, the way we date is even more inefficient!
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Our brain is a muscle and is conditioned by habits, whether they are good or bad. Habits form over time but our brains are hard-wired for short-term pattern recognition and rewards. Complacency, therefore will guide us humans toward the path of least resistance rather than the path to a meaningful existence.
“Habit is either the best of servants or the worst of masters.” ~ Nathaniel Emmons
“As a single footstep will not make a path on the earth, so a single thought will not make a pathway in the mind. To make a deep physical path, we walk again and again. To make a deep mental path, we must think over and over the kind of thoughts we wish to dominate our lives.” ~ Henry David Thoreau
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Great post.
I recently listened to the audio book by Dan Ariely (the name escapes me)but it was really insightful on why we do a lot of the things that we do.
This reminds me of a promotion that Chrysler is currently running about getting $2.99 gas for the next 3 years if you buy a new car.
Keeping these things in mind has prompted me to make big purchases using a very specific check list of features that are important to me before I even walk into a store, because I know that if I walk in simply saying, ‘buy a TV’, I will be easily talked into an upgrade based on a bunch of features that only sound good because a savvy sales person knew to play on my lack of research and planning. That’s one of the reason people end up buying extended warrenties and such.
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I also have a problem about saving money. I’m 22 and am saving nearly 40% of my income and think twice about going to get ice cream. Anyone else ever had a problem like this? I know its a good habit to have but I don’t want to end up like a Scrooge. Let me know what you think? Has anyone found a way around something like this?
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JD, thanks for putting this post up because I don’t think enough folks think about the behavioural aspects of personal finance. For any of those who wish to read a book that takes this whole issue further I heartily recommend Barry Schwartz’ Paradox of Choice. If you only read the first chapter about the complexity now implicit in the purchase of a pair of jeans, it is worth the cost of the book. As a culture we have gone from just going to buy a pair of jeans to having to decide whether it is pre-washed, pre-distressed, shrink-to-fit, casual fit, relaxed fit and on and on.
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I made a larger than usual purchase this past weekend (budgeted) and this one purchase seemed to open the floodgates of shopping. I ended up spending about twice as much as I intended to, because once I made the first purchase, it just seemed so much easier to rationalize buying other (non-budgeted) items.
My brain seemed to get that shopper’s ‘high’, and my old spending habits just kicked into gear. Luckily, I’m back on the wagon, and my budget is none the worse for wear, but it was interesting how quickly I reverted to pre-frugal spending.
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In his book A New Earth, Eckhart Tolle talks about how banknotes should maybe have a warning on them like the kind found on packs of cigarettes — “Warning: Money can cause complete unconsciousness.” A New Earth is the best book I’ve read about “Why We Buy What We Buy.” One of Tolle’s main premises is that people buy most things because they think the apparent solidity and permanency of a material object will somehow endow their own sense of self with greater solidity and permanency. This is why it’s hard for people to get rid of huge collections of things, like books or movies maybe, even if they don’t use those items anymore — their sense of “self” and identity have gotten all entangled w/ that stuff. Have you ever observed how young people are so caught up in the content of their Ipod? That collection of songs represents their identity and enhances their sense of self, so they are very careful about which songs they pick, and they obsess over the content. This is a collective delusion which adults share as well, though in the case of adults it might be cars, furniture, or clothes instead of songs. “Attachment to things drops away by itself when you no longer seek to find yourself in them,” Tolle writes. He says the beginning of the transformation of consciousness about this sort of stuff is to become “the awareness that is aware that there is attachment.”
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What a great post! I showed an Econ major the Standup Economist video you posted back in November, and afterwards, he was like ‘Oh, that was mildly funny, but not accurate. I mean, you learn in Econ 201 that people have to think on the margins for the world to go round.’ (Or something to that effect.)
I didn’t say anything, but it’s painfully obvious to anyone living outside the theoretical world of economics that people don’t think on the margin. Great analysis on some reasons why!
(And how does the saying go? “An economist is someone who looks at the world and wonders if it would work in theory”?)
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Hi. Maybe “being scared to spend” isn’t so surprising — considering that you just started self employement and every day the news is filled with stories of folks in bad situations faced with rising prices!
Still, if you (and Jay at #5) want to ensure that you’re getting some joy from your money, maybe you need to budget an amount and say “I need to spend this every week on fun.”
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I think your symptom of being scared to spend money is natural given all that you have sacrificed to get to this point. As you point out, “our habits affect our habits.” You have affected your old habit of overspending, and that’s a good thing!
Now that you are in control you can let the pendulum swing ever so slightly back to the middle. It’s almost as if we need baby steps to recover from living too frugally! One small purchase, one small vacation, one small completely frivolous item, etc. And there should be no shame involved – you have worked hard to get this to this point.
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My first thought when reading the bulleted list: The Standup Economist.
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Looking at the emotions that drive the bad financial decisions is important. Basically, the bad decision/action is the symptom. The underlying emotion is the cause. It’s easy to look at the symptom (overspending for example) but it takes work to look inside and find the root cause. Addressing the symptom just masks the problem. Working on the cause creates lasting change.
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Great Article
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JD – what you are going through is normal. You have a family, you want to provide the best for them and right now that involves saving and being a miser. You’ll reach a comfort point and you’ll loosen up the purse strings some. My father was the same way. Unfortunately he didn’t loosen up until a friend of his was diagnosed with MS and it made my dad realize how you need to enjoy life – and that means taking advantages of experiences. So my advice to you is to spend money on things that count – take trips with your kids, family, friends, etc. Those are great experiences – owning a Mustang GT probably won’t give you the fullfillment of that trip to Disneyworld with your kids. In other words use your money to enhance your life, not to accumulate stuff (but I think you’ve already figured that last part out).
Jay – You’ll work your way through this, too. I went from living on average wages to having my spouse triple his income. We save about 40% of our income now, too. But it’s hard to overcome your upbringing and not neccessarily bad either. Just don’t let impulse buying of ice cream lead to impulse buying of sports cars. It’s ok to think about every purchase you make – in fact I think its good, it grounds you in reality. Cause if you are lucky enough to save 40% of your income you are far ahead of the rest of the country – so stay grounded, but buy the ice cream.
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I fall closer to the scared to spend money category. Emotions still are a huge part of it though, because I’m much more willing to encourage my husband to spend on things that will make him happy. Like Frugal Dad said, it’s time to focus on getting back to the middle and finding a balance between my wants and needs and my spouse’s as well.
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As an example, given three choices, cheap,
midline, and expensive options, nearly all people will go for the midline options. (And think–this isn’t even a situation in which you’re being paralyzed by choice by vast numbers of different products!) So middle of the line items are priced so that the companies selling them can make more profit on something that actually may be only slightly better than the cheap option anyway. If I recall correctly, this often works for things as simple as different sized boxes of cereal. And, by the way, stores know these things, and if they don’t they hire people who do to redesign their sales floors.
Even the phrasing can trip us up: Consumers told there was a 60 cent charge for using ATM cards at a certain gas station were much less likely to use that gas station than those told that they’d get 60 cents off for using cash. The funny thing? The ratio of people using cash to those using ATM cards stayed the same. And a lot of people felt like they were saving money by using cash in the latter situation, despite the fact that they paid exactly the same amount of money as the people who felt like they were just paying the price.
Things like this are why I’d certainly rather be a miser than not–even if you’re bordering on miserly, at least you’re not just *feeling* like you’re saving money. You actually are. I also tend to feel like spending can open floodgates–its something my husband and I have worked really really hard to control, especially with eating out and that sort of thing. I think the trick is not to train yourself to be a miser, but to train yourself to shut off the floodgate of spending sooner. Let yourself have good budget days and bad budget days; the trick is to just change the ratio of one to another without making yourself miserable in the process.
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“Increased choice makes us less able to choose. ”
Couldn’t agree with this more. I usually let my wife pick out wall paint, for example, because I am paralyzed by the bewildering array of colors that look to my eye exactly the same, but are subtly different. When you compare the two colors side by side, I can see the difference, but I have no mental concept of why one would be any better than the other.
Same goes for high-end electronics. When we bought an HDTV, I had to rely on a friend who was knowledgeable in that area and satisfied with his tv because of the bewildering array of choices.
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Tibor Scitovsky began combining behavioral psychology with economics in the early Seventies. His book, “The Joyless Economy” was the starting point for my law-school thesis on how replacing our federal income tax with a consumption tax might encourage Americans to reevaluate our spending habits and the things we look to for happiness and satisfaction. I’m very happy to see that vein of research is continuing.
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My Mom is now eligible for medicare but only has 2? months to commit to a plan; each one is different in their own way, with coverages, medications they cover and at what price, etc. Even though they say choice helps the consumer, it actually hurts consumers and benefits companies if the choices are so many and there is no clear and efficient way to compare between them.
I think the health care system is broke because it is not an open system and costs are hidden: you do not know costs up front so there is no way to comparison shop. Therefore market efficiences cannot operate to give us the best healthcare for the best price.
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“Money is more about mind than it is about math. Our financial decisions are often based on psychology and emotion rather than on pure numbers.”
I would argue that bad money decisions are more about the mind than about the math.
Using data and numbers to figure out the best way to invest your money is the way you make a good decision.
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On the one hand, you don’t know very many poor misers.
On the other hand, most of them aren’t very happy.
Having been on this path for a while I have found that I spend less and often avoid spending whenever I can. I budgeted and saved the cash for a new laptop computer over the course of nine months. The model I had was nearly 6 years old. After saving enough to pay cash for a new Macbook I continued to use the old laptop for another 8 months because I liked the idea of having money in the bank.
When it finally broke and needed to be repaired I talked myself into getting a new one.
Still, I don’t feel I’ve become cheap or a miser. I live comfortably and am very happy. I think one key is that I am now able to give a significant portion of my income away. Before I got things going a 10% tithe to my church was a challenge. Now I am able to give 15% of my income to a number of charitable organizations without a concern for my own expenses.
Maybe the key to not becoming a miser is to not hoard your money after you learn how to manage it.
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Jay, I would sit down and think about something you would really love to do, or have wanted to do since you were a kid. Maybe it’s taking a month-long trip through Italy, or learning to drive a race car, or seeing a match at Wimbledon. Figure out how much it would cost, then start setting money aside for it…and when you hit your goal, DO it! So many experiences that seem “only for the wealthy” are absolutely attainable by anyone — it just might take a bit longer to get there. You can still save aggressively for retirement, but putting money aside for an experience that is purely “yours” feels exciting and satisfying.
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@ Jay (#5):
I’d say that saving 40% of your income is not necessarily a bad thing, as it depends entirely on your reasons for doing so.
For example, I am also currently saving 40% of my income, which is $1,270/month (grad student stipend). While some is going to my usual IRA contribution, emergency fund, car repair,and home improvement funds, the largest chunk is going into a special ING direct fund aimed at providing me with income for next summer, when I very likely will not get any funding from my university. My budget isn’t pretty, but I’ve still managed to sneak in a few treats (though I also triple-think about an occasional ice cream).
You just need to decide whether the reason that you are saving such a large portion of your income is worth the smaller joie de vivre sacrifices that go along with saving. For me, the security of knowing I’ll have money to pay my mortgage and bills next summer is more than worth it. If, however, you are looking at a stable income source for the foreseeable future, I would definitely consider building some more small amounts of “fun” money into your budget.
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Great point, sunk costs are really important because they should never enter into your decision making.
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The Dan Ariely book is Predictably Irrational – I thought it was really interesting. (It was hard to spend so much money on a hard back though, I’m kind of miserly so I would normally wait for a used soft cover.)
As I’ve been reading this blog I’ve wondered when this issue of having a hard time spending would come up. This has been a pretty big problem for me and I hope it doesn’t become too bad for you.
What has helped me are big ticket travel items once in awhile – like a major vacation that is full of activity that will be really fun while I’m young and can endure crazy travel. Activities are an easier sell for me because we’re not interested in accumulating stuff.
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Another interesting point that was in that article is that traditional economists dont take behaviour into account when planning policy.
This kind of worried me a lot as…if govt economists are ignoring human behaviour, how useful are all of their plans and recommendations…?
Though provoking stuff!!
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Economics, or dollar measures, is a flawed measure. It undervalues all kinds of important factors such as the environment, relationships, health. The woman who traded in a gas guzzler was operating on a different theoretical basis – that reducing her contribution to global warming has more value than the cost of the gas over the lifetime of the car. And when gas is $12 a gallon, it will all look different.
Good reading on this: The Economics of Happieness by Anielski. His economics endeavors to take in quality of life and environment in the GDP.
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