Is Your Brain Making You Poor?
Unfortunately, human brains aren’t exactly wired to help make us wealthy. At least that’s the opinion that behavioral economists have, thanks to what they say are evolutionary quirks about how humans not only view the world but also make financial decisions. In fact, they say we often do exactly the opposite of what we should do when it comes to money and acquiring wealth.
Luckily there are a number of ways to work around these mental shortcomings that we have and, in some cases, even use them to our advantage. Below our own number of “mental patterns” that tend to make us poorer, and a number of ways that you can overcome them. Enjoy.
Mental Pattern #1: Mental Accounting
Humans tend to treat different sources of money, and different sums of money, differently, depending on the source of that money as well as how it’s used and where it’s saved. For example, have you ever noticed that you tend to spend more money when you use your credit card then when you’re using cash? Mental accounting is at fault here because we see money spent using credit cards as less “real” than cash.
The easiest way to overcome this mental pattern is simply to use cash. You can also set up sub-accounts at your bank, which most banks will allow you to do for free, and then label all of them for a different purpose. If you have one that’s labeled “Caribbean vacation” there’s a much better chance that you won’t dip into it then if it’s just labeled “savings”.
Mental Pattern #2: Hyperbolic Discounting
Humans, unfortunately, are big fans of short-term satisfaction but not so much when it comes to long-term gain. In fact, the further in the future a benefit happens to be, the less we value it. (It’s no wonder many people have trouble saving for retirement.) This hyperbolic discounting means that humans are very shortsighted when it comes to saving for the future.
One way to overcome this mental pattern is to make saving automatic. If money is taken out of your check before you even see it, and deposited into your savings, IRA or 401(k), there’s much less chance that you’ll spend it. Visualizing your goals is also an excellent idea to overcome this problem, including pictures of the place you want to retire or the beautiful home that you like to have some time in the future. This makes your goal much more “real”.
Mental Pattern #3: Loss Aversion
Interestingly, humans hate losing money about two times as much as we love gaining money. If you know someone who doesn’t invest in the stock market because they’re worried about potential losses, you know exactly what we’re talking about.
In order to get around this problem, you need to limit your exposure to the “noise” of the stock market. For example, stop checking your portfolio every day and start checking it once a quarter, or even once a year. The fact is, what’s happening today in the market will have very little bearing on what your investment will look like in 10, 20 or 30 years.
Mental pattern #4: Status Quo Bias
Another unfortunate fact about humans is that we’re rather lazy. In fact, a couple of British researchers described this problem as an ‘exaggerated preference for the status quo’. It means that, rather than taking a proactive course of action, we stick with what we have because it’s easier.
One way around this is to sign up for automatic increases of your 401(k) contributions at work. Some companies do it automatically but some don’t and, if your company doesn’t, you need to get yourself down to human resources at least once a year to make sure and boost it yourself.
Like we said at the beginning of this blog article, our brains aren’t exactly wired to make us wealthy. Hopefully the information we provided you today will enable you to convince your brain to do otherwise.