Psychology of Money

Battle Strategies for Rational Behavior

Our brain’s limbic system is emotional; focused on now; and fears loss.  Our brain’s rational cortex system is logical and does not put emotions on time frames. Therefore, successful strategies to overcome our limbic system’s emotional influence on decisions where we need to be rational do one of two things:  1) change the rewards and penalties in future decisions; and/or  2) change the number of “decision points.” Giving Ourselves Rewards and Penalties What kinds of rewards might we set up for future decisions?  They don’t have to be financial. More success comes from social rewards.  Charities tend to use this fact. For example, most fundraising events revolve around the social rewards of belonging to a group, and supporting a good cause.  So before heading out to the event, we can write our check in advance for the amount we wish to give.   In another realm of behavior and choices, rather than attempt a diet solo, we can agree with a group of friends to commit to a weight-loss plan. What kinds of penalties can we set up for ourselves?  In the financial world, we can make funds unavailable. Christmas club accounts; requesting excess tax withholdings; and pensions accomplish this.  We can choose products with actual penalties, like CD’s and annuities.  We can choose investments with high costs to buy and sell, like real estate, or a business. Other penalties we want to avoid are “felt losses.”  We feel a loss when we have to pay to work out or take a yoga class.  To increase the likelihood of doing the desired behavior, we can prepay for “painful” behavior changes. Professionals who charge by the hour could change to flat-fee arrangements to avoid making their client incur a “felt loss” every time they meet with them. Decision Points Another way to trick ourselves is to manage “decision points.”  We should increase decision points for options that are hard to resist, and decrease decision points for options that are hard to do.   Here are some examples: In one study of the “hard to resist” kind, people ate less than half the number of cookies when they had to individually unwrap each one.  The act of unwrapping added a decision point to the process of eating the cookie. In the “hard to do” category, successful savings and investment programs are often automated, eliminating the decision point of manually making a transfer from a spending account. Debtors can request a credit freeze through reporting agencies, forcing them to go through a “thaw request” in order to get more credit. During the 2008 stock market meltdown, Dan Ariely, a Duke psychologist who studies behavioral finance decisions, knew he might be tempted to do something rash in his investment account.  So, he purposely input the wrong password three times so that he would be locked out.  This kept him from selling into the downturn. Think you’re above your limbic system?  Studies find that the cortex consistently overestimates its abilities.  In fact, winning the cortex/limbic battle isn’t…

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Our Dual Selves in Financial Decisionmaking

Neuroscience finds there are two players in every decision we make: 1) Our patient self (in our cortex); and 2) Our immediate gratification self (in our limbic system). At a Financial Planning Association conference in May, Professor Russell James of Texas Tech University presented his findings from MRI images of people asked to make decisions.  In financial decisions, the cortex shows no difference in reward over different timeframes.  In contrast, the limbic system shows higher reaction to immediate reward, even when it is for less money now, rather than more money later.  This leads to a problem called hyperbolic discounting. Would you rather have a) $100 now or b) $101 in a week? How about a) $100 in 52 weeks, or b) $101 in 53 weeks? In an oft-quoted study on hyperbolic discounting, more participants chose b) in the first question than in the second question, even though the return is the same – 1% over a one-week period, or approximately 52% on an annualized basis. Here’s a Weight Watchers example. Given an unhealthy snack choice now or in one week, 70% chose the unhealthy snack now; 26% chose the unhealthy snack in a week. The fact that our limbic system overrides our rational thinking is not surprising. But how can we change? Professor James has developed “pre-commitment strategies” that alter our future environment and/or our time preference. When it comes to our future environment, time and effort spent appreciating future pleasures can evoke enough emotion to satisfy our limbic brain. To entice retirement savings, a financial planner might ask a client to envision a day in the next chapter of their life in great detail – immediate surroundings, who they are with, what they are doing, what they smell, what they feel (i.e. sand between their toes, or hugging a grandchild). Capturing that image as a financial goal can be more powerful for some clients than simply being obliged to save for a nebulous future. In a 1998 survey of participants over 50, it was found that the longer the time horizon they were concerned about, the more wealth they had after eight years. This study shows that the "propensity to plan" - the more time you spend visualizing the future state - the more wealth you build.

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Why Money Can’t Solve Our Problems

“I don’t know who I am or what I want. I just know I want to make more money and then I’ll figure it out and be happy.”  Ever felt this way?  At one time in my life, I sure did. If you are reading this, most likely, you have a full tummy most of the time, shoes to protect your feet, a closet full of clothes, and an apartment or a house to keep you dry and comfy.   You were taught to read.  You have several years, maybe close to two decades, of education.  You may have participated in sports or music or arts or outdoor activities.  You may have experienced love in one or several different forms – from your parents, friends, siblings, a pet,  a spouse, or from a child.  To most of us, these are just the basics.   Take away any of these “basics,” though - our physical needs, our literacy, our leisure, and our love -  and we become seriously unhappy. In contrast, how much did your happiness increase when you got your last new car? How about your last new outfit?  Your last new set of towels?  Your last bag of groceries?  How long did the happiness last? Think about each of these things as if you had never had one before.  How would the change in your happiness level compare then to just replacing an old one? Once we reach a certain level of wealth, each additional dollar brings us a diminishing unit of additional happiness.  Economists call this a "diminishing marginal return." Even though we have scientific studies confirming money's diminishing marginal return to happiness, we still seem to think, “If I had more money, I could do or have that,” or “I can’t do or have that, I can’t afford it,” or simply, “I would be happier if I had more money.”   Is this really true? Money does give us choices.   We like having a choice between Lexus and Toyota.  We like latte and cappuccino.  We like menus.  We like variety.  We like Sam’s Club. Before thinking more money was the answer to a problem, though, I think about whether there was anything else I could give up to get what I want?  If it didn't involve giving up the "basics," then I could afford it.  I just didn’t choose to. If we want our money to work for us, it has to be efficient.  It can’t be wasted on unimportant things.    If we cannot be clear about what's unimportant, though, we are likely to find ourselves perpetually wanting "more," which is a prescription for perpetual unhappiness. In The Seven Habits of Highly Effective People,  Stephen Covey wrote about the “Abundance Mentality.”  Having an Abundance Mentality means living as if there are plenty of resources and money to go around for everybody.   Ironically, once we precisely define what we want in our life, the world does appear far more abundant.  Life is no longer  a game of scarcity and competition. By…

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