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Wealth is in the mind, they say. Is it true?
It’s easy to argue that there’s more to life than money, but it doesn’t take much to see how big a role it plays in our lives. Money puts food on the table, sends us to school, pays our hospital bills, puts a roof over our heads and clothes on our backs. The average adult spends half his day in an office so he can pay for a home he can barely spend time in. Money is so important, in fact, that we’ve come to incorporate it in our psychology.
Here are some of the ways our minds play games with us in money matters—and how you can overcome them.
Social spending: Your friends may be making you poor
Peer pressure accounts for much of what we spend on. Teens buy the same clothes as the popular kids at school, young adults rent flats in the same neighbourhood as their buddies, yuppies drive the same cars, older people go on the same holidays. We have a subtle need to fit in, to meet a certain standard of living. And while that may not always be a bad thing—peers can set a reasonable standard and keep you on track—it often works the other way around. We’re willing to spend more on something socially acceptable than scrimp and go for what’s practical.
Another concept worth looking at is groupthink, or the way people in a group agree to the same things to avoid conflict even if they logically would think otherwise. When your department decides to pitch in for a new coffee maker, it’s easy to nod and agree. Your calculations may show it’s much cheaper at the cafeteria, but you don’t want to break the peace. But the same concept is at work when you agree to a night out or a weekend trip, things that cost significantly more.
Delayed gratification: Making sacrifices
A famous experiment by psychologist Walter Mischel in 1972 showed that kids who could defer gratification (by resisting a marshmallow for 15 minutes in exchange for a second one) had higher SAT scores and generally fared better as adults than those who couldn’t wait. In the realm of personal finance, delayed gratification defines your ability to save, to resist impulse buys, and to let future needs prevail over present desires. It doesn’t take a doctorate to understand the ant-and-grasshopper moral: those who work and save will be more prepared for hard times than those who sit back and spend without question.
The good news is that delayed gratification can be learned, even as adults. Although children are predisposed to it to different degrees (poor children will be more inclined to save than rich ones, for example), at a certain age it does level out. Make it a habit to live on less than what you’re making, and put as much as you comfortably can in meaningful investments such as a high-interest savings account or a retirement fund. Setting goals and making long-term plans can give you an incentive to set more money aside, and will make it even more satisfying when you do indulge.
Loss aversion: Losing vs. winning
We hate to lose more than we like to win. Several studies have confirmed that losses affect humans twice as much as gains of the same degree; we lose twice as much pleasure in a $50 loss than we gain in a $50 windfall. We take it so hard, in fact, that we make irrational decisions out of our fear of losing.
Take investments, for example. A large majority of the workforce opts for a government or company retirement plan, where all the decisions are made for them. This is the “safe” way to go; your capital is protected and you’re assured of a minimal gain (which is better than nothing). But those who take just a little more risk and invest in the stock market stand to make ten times more in the long run. Yes, they also stand to lose, but it’s a price they’re willing to pay.
Even stable investments will have ups and downs over time, but people can take the downs too negatively. Look instead at historical averages. Standard & Poor’s index has had annual returns averaging 12% in the past several decades, so even in the midst of a recession, you can be pretty sure your portfolio will get back on its feet. More often than not, a bigger risk appetite pays off in the long run.
Mind over money: Assessing your beliefs and values
Perhaps what makes the biggest impact in our financial decisions is our personal beliefs, and therefore our values. When your beliefs favour living in the moment, you may put more weight on enjoying current trends than preparing for future ups and downs. People like these are less likely to be able to delay gratification, resist peer pressure, and choose promising investments. But if you were raised to be careful and calculating, you’ll probably by smarter with your purchases, although you do risk being too risk-averse.
Values are a closely related concept. Your values are, in a nutshell, what you consider most important. Family, friends, career, personal growth and satisfaction—whatever it is, it’s where you’re likely to put most of your time, effort and money, whether or not you’re aware of it. That’s why some people put a third of their income into a mortgage, while others prefer to rent and live a pack-and-go lifestyle.
A good start to better financial management is to reassess your beliefs and values. After all, these are the things that guide your decisions, and more often than not, keep you from reaching your potential. Take a couple of hours to write down your priorities and see if they’re in the right order. You may be putting importance on all the wrong things, or focusing on goals that shouldn’t even be on the list. It may take a major paradigm shift, and it might take some getting used to, but you’d be surprised at what a few mental tweaks can do.
