What was I thinking? How to change illogical money habits into positive actions
Read, 4 minutes
Key takeaways
- Thought patterns we’re not even aware of can lead us to make financial decisions that we question later.
- Understanding these patterns and their potential consequences is a first step to changing them.
- Specific steps that add structure to our finances can help us build healthier money habits.
A driver goes miles out of their way for cheap gas. A car owner refuses to part with a lemon because they’ve spent so much on repairs. A homebuyer saves for a down payment from every paycheck, but goes on a shopping spree with their tax refund. A fashion lover keeps buying trendy clothes they can’t afford.
We all know at least one of these people. If we’re truly honest, we may be one of these people.
Any of these actions may have seemed like a good idea at the time. But psychologists say they are examples of irrational thinking. Research shows that emotions and unconscious thought patterns, called cognitive biases, play a big role in financial decisions. As a result, it’s common to develop irrational, sometimes quirky, money habits that go against our financial well-being.
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The brain works in mysterious ways
Psychologists say our upbringing, culture and societal norms shape our relationship with money. Our friends contribute, as do our personal experiences. Beyond our backgrounds, irrational and illogical behavior—financial or otherwise—can be explained in part by thought patterns that we’re largely unaware are happening. These examples illustrate some common patterns:
The driver’s quest to save a few cents per gallon on gas is motivated by pain of paying—the feeling of loss often experienced when anticipating or making a purchase. The discomfort of paying a higher price for gas close to home makes the driver overlook the value of the time and fuel used to find the lower price.
The car owner hopes their vehicle will finally run well and justify the money they’ve spent on it. In fact, they’d be better off cutting their losses and getting another car. This is an example of the sunk cost fallacy—sticking with a losing endeavor because we’ve already put time, money or effort into it.
The homebuyer places a higher value on money from their paycheck than their tax refund. If they had saved the refund—or at least some of it—they could have reached their down payment goal sooner. This is called mental accounting—treating money from one source differently than money from another. It can lead to counterproductive spending with the money we treat more casually.
By basing buying decisions on trends, social media and friends, the fashion lover overspends on clothes they don’t need and may not ever wear. They’re caught up in herd mentality—following the crowd to achieve a sense of belonging, regardless of whether the activity is good for us. This is a form of peer pressure.
How to make more rational decisions
Understanding these thought patterns, behaviors and potential consequences is the first step toward making more rational decisions. But education alone may not be enough. It’s tough to think our way into new habits. Many of us need actionable plans—with structure and self-control strategies—to reframe our relationship with money. For example:
Make a personal finance plan. This helps take some of the emotion out of financial decisions. Start by setting goals. Do you want to take a vacation? Buy a house? Continue your education? Then track your spending so you know where your money is going. Use that information to help create a budget that covers your needs, wants and savings. There are lots of online tools and apps that can help.
Create an if/then plan around our goals. We’re more likely to reach our goals if we consider potential diversions—both positive and negative—and then plan specific actions to address them. Here’s how to do it.
Automate finances as much as possible. Have bills, credit card payments and savings automatically withdrawn from a checking account. This reduces the chances for emotion-driven decisions and makes it easier to stick to a budget.
Make impulse buying harder. While automating finances is usually a good practice, low-tech is better when it comes to discretionary spending. Type in credit card information for every digital purchase, rather storing it in an app or online site. Pay with cash, rather than credit cards, when shopping in person. And institute a 24-hour cooling off period before making a purchase.
We may shake our heads at irrational financial decisions made by friends and family. And yet, we can relate. Odd habits illustrate the human side of money and offer valuable lessons in ways to improve our financial well-being.
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