Ever look back at financial decisions and ask: Why did I do
Turns out, science can probably answer the question. Welcome to
the Nobel Prize-winning field of "behavioral economics."
Its mission: to look at how we humans are hardwired to perceive
things such as value, abundance, scarcity and the future -- then
analyze at how that relates to our financial decisions.
So not only can you learn from your mistakes, you can also learn
a lot about what was going on in your head when you made them. Here
are six money mistakes we commonly make -- and their behavioral
1. Buy now, pay later
Do you tend to spend more when you pull out the plastic than when
you count out the cash?
Study after study finds that it's true for most of us.
Part of the reason: With cash, your brain registers that the
money is really spent, says Douglas E. Hough, associate scientist
with the Johns Hopkins Bloomberg School of Public Health. You pull
it out of your wallet, count it out and hand it to the
cashier. That money is literally gone.
With a credit card, you hand it over, but the clerk gives it
right back. "You don't see the result of the transaction until a
month later," he says.
Hough points to economist Amy Finkelstein's work as a good
example of how we let ourselves be taken by out-of-sight payments.
Finkelstein, an MIT economics professor, found that states that had
electronic toll collection systems would raise toll rates more than
states that didn't, Hough says.
Consumers don't notice those changes in the same way when they
aren't handing money to a toll taker or throwing it into a bucket,
says Hough. Instead of counting and doling out quarters, "it just
shows up in a bill" once a month, he says.
And, when you don't pay cash at that moment in time, "The mind
is almost saying 'I'm getting it for free,'" Hough says.
2. 'Bill creep'
Automated bill pay, a favorite of retailers, service providers and
financial institutions, makes use of a similar lack of tactile
payment, says Hough.
"The argument, from the standpoint of a retailer, is that this
makes it much more convenient for you, it's automatically
done for you," and it's always paid on time, he says. Some
will even give a discount if you set up automatic bill
"What happens is that it takes the consumer out of the stream of
purchase," Hough says. "The salience is reduced. You don't realize
how much you spent." And, if charges increase incrementally or
previously free services start carrying a fee, you're less likely
to notice or do something about it, he says.
Once you put a bill on automatic, "You don't even think about
it," Hough says. "So you aren't shopping around or cutting
services. That takes work."
3. The value of now vs. later
Many financial decisions, from retirement planning to those
supposedly interest-free credit deals
, involve weighing the value of money now versus its more hazy
The problem? For human beings, ciphering the true value of
resources at a future date doesn't come naturally, says James E.
Burroughs, a University of Virginia commerce professor who
specializes in consumer behavior. "Human beings are very short-term
oriented," he says. Possibly, because "most of humanity's existence
is getting through the here and now," he adds. "So that's how we
Given a choice between a small, immediate reward now or a very
large reward deferred into the future, "human beings will typically
take the immediate reward," Burroughs says. "That's why we don't do
well with financial decisions," he says. "It's why we have credit
card balances. It's why we don't save for retirement."
4. 'Hot states' and big debts
Ever take out a payday or title loan, carry a balance on a
high-interest credit card or get a cash advance on your plastic? If
so, you were likely consumed with the idea that whatever you were
buying (whether it was a visit to a Vegas casino or the local
emergency room), you had to have it now.
In those situations, called "hot states," consumers "are driven
by emotion, not thought," says David Just, a professor of
behavioral economics at Cornell University. They're convinced that
having the money immediately is more important than what they
eventually have to pay for it, he says.
Consumers coo to themselves, "I'll do better tomorrow," and
"Everything will take care of itself." Not thinking about outcomes,
they're "just convincing themselves to do something wrong," he
says. "And it can be devastating."
5. Fun vs. savings
That same type of thinking makes it difficult to picture future
money problems, Burroughs says. While financial planners are
advising us to tuck away three to six months' worth of expenses as
an emergency fund, "that requires us to comprehend a future that
we're not very good at comprehending," he says.
So your mind might hit a roadblock when you compare postponing
buying that gaming system that you know you want, in order to save
money for a job loss, roof leak or washing machine breakdown that
hasn't happened and may never occur.
"We deal in this world that requires intertemporal trade-offs,"
says Burroughs. "And we're not good at understanding them."
Skipping a workout, eating a plate of chocolate chip cookies, or
forgoing that savings contribution one time isn't that big a deal.
But we have trouble calculating the cumulative effects of those
same actions repeated over months or years, he says. "We're wired
to deal with the here and now," Burroughs says. "We're not good at
considering long time spans."
This is one area where putting your finances on autopilot may
actually help you, he says. Have money for your savings (or
retirement or college) automatically deposited into an account,
Burroughs says. "You never lost it, because you never had that
money in your life to begin with."
6. Too many fees
Sometimes those small, repeated mistakes aren't something we
actively do, but something we simply don't change. Those passive
decisions can be even more costly, says Just.
Some examples: Putting up with a credit card rate hike, using a
financial institution that constantly levies fees or ignoring
small, unwanted charges on a bill month after month.
"If you're looking at this as a single instance, then you tend
not to care," says Just. The problem: "It is a single instance, but
it will be followed up by a thousand more. This is what allows
companies to change convenience fees. And creates prices that are
The lesson from behavioral economics?
"I think the real key is nobody's perfect," says Burroughs.
"Nobody can avoid making all of these mistakes completely."
But when you learn how and why you're vulnerable, you can set up
routines that help you compensate, he says. "To the extent that you
make yourself a creature of habit -- financial habit -- the better
off you'll be, and the less stressful your life will be."
"Pay attention to the little things," Just advises. "Don't just
re-evaluate your retirement. Re-evaluate the decisions you're
making day to day with your money."
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