Have any of these thoughts ever crossed your mind?
If I had more willpower, I’d achieve my financial goals.
I’m doomed to fail with money.
Budgets suck. They only show me what I did wrong and make me feel horrible.
If so, you’re not alone.
It’s not that you lack willpower.
It’s not that you’re doomed to fail with money.
It’s not that you’re a horrible person for blowing your budget.
It’s that you’re human.
And humans make emotional decisions all the time. Decisions that often defy logic.
But making emotional decisions doesn’t have to be a financial death sentence. Money management is a skill, which means we can improve.
When we understand the “why” behind our decisions, coupled with the marketing tactics that retailers use, we can guard ourselves against cognitive biases and sales strategies.
That’s what today’s guest is here to discuss.
Jeff attended Princeton University and practiced as a lawyer before he became an author and a speaker. He co-authored Dollars and Sense with Dr. Dan Ariely, a bestselling book that explores behavioral economics and asks why we make faulty financial decisions.
In this interview, Jeff names five common money mistakes and offers four solutions.
Five Common Money Mistakes to Avoid
Financial missteps are often invisible. Our minds tricks us into believing we’re making the logical choice, when in fact we’re acting on our biases.
The good news is that missteps are easy to avoid once you know how to spot them. Let’s dive in.
#1: Overvaluing Sales
Scoring a deal feels amazing, right? Every time you pay less than full price, you win.
But what if you didn’t pay anything at all?
As Jeff notes, the thrill of winning can lead you to spend more than you otherwise would have.
“You would buy a shirt that was $100 [that’s] marked down to $60 more frequently than you would just buy a $60 shirt because you have that easy comparison … relative to a $100 shirt, a $60 shirt is a great deal. Whereas the challenge of figuring out what a $60 shirt itself is worth, without that comparison, is difficult.”
Our brains love shortcuts, but shortcuts don’t always like context. There’s nothing frugal about saving 50 percent on an item you wouldn’t have purchased had it been at full price.
Fifty percent off is still 50 percent on. Sales are tempting, but you can avoid the temptation with a written spending plan. Create a shopping list before you enter the store. Or adopt the anti-budget.
#2: Overlooking Opportunity Costs
Mentally earmarking money for a specific purpose can backfire, causing you to overlook opportunity costs.
Here’s an example:
You save $30,000 to buy a car. You begin to shop for a car with $30,000 in mind. The longer you search, the more attached you become to spending that $30,000. It doesn’t cross your mind that you can spend less than $30,000 on a car and save the rest for something else.
This happened to a group of graduate students from Dr. Dan Ariely’s class. The students were taken to a Honda dealership and were told that they had $30,000 to spend.
“…[Dan] asked people, ‘You’re about to spend $30,000 on a Honda. What else could you spend that on?’ And people couldn’t think of anything … the most they got was people said, ‘Well, if I don’t spend $30,000 on a Honda, I can spend $30,000 on a Toyota.’ That’s not spending your money on something else, that’s just [a] different brand.”
When you earmark money for a specific purchase, ask yourself:
- Do I need to spend this entire amount? If not…
- … what else can I use this money for?
These questions can help you maximize your savings and keep opportunity costs in sight.
#3: Numbing the Pain of Paying
We’re wired to avoid pain. But experiencing the pain of paying can help us save money.
“The pain of paying reflects this finding that when we … hand over a $20 bill at a counter, it stimulates the same region of our brain as physical pain does.
…what ends up happening, in our modern world, instead of feeling that pain, we numb the pain. We use devices to make it so that we don’t actually feel it.”
When you make a purchase with your phone or with plastic, it’s painless. The loss of money is invisible and intangible. This disconnect can lead to further spending because there’s no perceived consequence.
Instead of paying electronically, try a week-long experiment in which you pay for things with cash. Does making a payment in cash have a bigger emotional impact?
Pick the payment method that causes you to viscerally feel the emotion, the pain, of losing your money.
#4: Putting Distance Between Payment and Use
Think about your subscription services. Do you ponder the monthly fee every time you use that service? Are you aware of making these payments each month? Or is the payment automatic, such that you never think about it?
Jeff illustrates this mistake with something many of us are familiar with – Amazon Prime.
“We just went through the shopping season and I’m sure plenty of your listeners used Amazon.com because they had free shipping. Well, no, they didn’t have free shipping. They paid for Prime…but it felt free.”
One year of Amazon Prime is $119. Even if you bought 119 items from Amazon over the course of the year, you paid one dollar in shipping for every item. You don’t think of it that way because the time between paying for Prime and receiving items can be months apart. You become disconnected from it.
As another example, do you think about the $10 per month you spend on Netflix when you watch a movie on there? Do you think about the $10 per month you pay each time you listen to a song or podcast on Spotify?
One last example: you pay $50 per month to go to the gym, and you go to the gym five times per month. Is each visit worth $10?
When there’s distance between the time of payment and the time you use a service, don’t shrug off the payment. Instead, make a conscious decision to continue to pay. Question your subscriptions each month. Do they still bring you value? If yes, then keep them. If not, cancel them.
#5: Overvaluing What You Own
We tend to overvalue the items to which we’re emotionally attached. There are two downsides to this:
- We often overprice belongings we want to sell. This can cause us to lose a sale. For example, homeowners overprice their homes because they overvalue their emotional experience of living there. That emotional experience is irrelevant to buyers. Overpricing a home can lead to a delayed sale.
- We’re vulnerable when we’re emotionally attached to brands. When a brand is part of our core identity, we spend more, even when it doesn’t make financial sense.
Jeff uses Starbucks as an example:
“You’re a Starbucks coffee drinker, but you could save a dollar a day by drinking Pete’s that’s next door and even closer to your office than the Starbucks is. But you’re not going to give up because the value just by being connected … is great.”
To overcome this, think about the identity that you want to craft and challenge the assumptions you have about your current identity. Which spending habits are serving you, and which aren’t?
Four Ways to Save Ourselves from Ourselves
Those are the five ways we trip ourselves up when making financial decisions. What are the solutions?
#1: Be Specific and Personal with Your Plans
Which plan sounds more fun?
“I’ll retire in 12 years”
“I’m going to retire on August 23rd, 2024. The first thing I want to do is rent an Airbnb on Lake Michigan for three months. I’ll start each morning with a run, and then I’ll make a luxurious breakfast from scratch. I’ll enjoy my breakfast while reading the news.”
The first example is nebulous. You don’t know what retirement will look like, and you don’t know exactly when you’ll retire.
The second example is concrete. You have a clear vision of what you’re striving toward and saving for.
As Jeff notes:
“…the more you can make your future concrete, the more you connect to it and the more you’re going to behave in a way that’s responsible for that future self.”
Nebulous thoughts don’t bring visions to life. Aim for specifics.
When will you retire? Where will you go? What will you do?
When you complete this picture, you’ll have a better idea of what you’re building for your future self. This can motivate you to make better decisions for the sake of Future You.
#2: Hide Money From Yourself
Are your checking and savings accounts at the same institution? Do you check Mint or Personal Capital and see all of your money at-a-glance?
This can be problematic. When you think you have more money to spend, there’s a good chance that your spending will increase.
You can avoid this by having accounts at different financial institutions. Set up your account such that when you log into your checking account, your checking balance is the only thing you see; your savings balance is absent. This tricks you into thinking that your checking account balance is all you have available to spend.
You can take this a step further and automate transfers to different accounts. For example, you can transfer $200 per week from your checking account to your travel fund, further reducing the available funds you see.
Jeff explains the benefit of this strategy:
“Suddenly we’ve hidden $200 a week from ourselves, and … when we look at our ATM receipt that’s on our checking account or our debit account, we’re going to think we have less money to spend…”
Lower your limits. Figure out how much you need in your checking account and put the rest of your money into savings accounts at different institutions.
#3: Visibly Track Your Financial Progress
Spending is visible. That’s why “keeping up with the Joneses” exists. Our competitive nature tells us to spend more in an attempt to outdo our neighbors or peers.
By contrast, saving isn’t visible.
Jeff describes this dynamic between saving and spending:
“We see spending, right? We see our neighbor’s clothes and new car … And by its nature, that drives us to be competitive, right? FOMO and keeping up with the Joneses … We never really talk about or see savings or investing. That stuff is invisible. In fact, more than it being invisible, like when you save money for the future, what do you see now? You see less.”
Don’t focus on outward appearance. Instead, make your smart decisions visible.
Keep a post-it note on your bathroom mirror on which you track your savings or investments. Create a chart that shows the growth of your net worth and make it your phone or desktop background.
Positive reinforcement occurs when you make your good financial decisions visible. This increases the likelihood that you’ll continue to make decisions that serve you, rather than hurt you.
#4: Create an Identity Around Saving and Investing
Are you part of the Financial Independence Retire Early (FIRE) community? Then you’ve already achieved this step.
(If you’re not part of the community, join the Afford Anything community on our private platform, for free. We discuss everything from personal finance to the FIRE movement to getting out of debt and starting a side hustle.)
Jeff says that creating an identity around saving and investing forges a greater connection between yourself and these values:
“I think part of the success of this FIRE movement … is this identity, right? You’ve created this identity of like, I’m doing something now for my future, and if you can … find a way to make that visible and tangible, you’re going to be more connected to making good financial decisions.”
When you make good financial decisions, you reinforce your identity as the type of person who is great at managing money. This creates a virtuous, self-reinforcing cycle.
- Dollars and Sense, by Dr. Dan Ariely and Jeff Kreisler
- Jeff on Twitter
- Dr. Dan Ariely
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