Behavioral economics affect our decisions about money: Part 3
Understanding the psychology of financial behavior can improve our overall financial health.
Behavioral economics is basically about trying to better understand why people make certain choices and in turn what can be done to improve those choices. The first article observed the concept that the more a consumer understands their financial decision-making, the better they can adjust their lifestyle choices to create a healthy financial future. The second article shared solutions to behavioral challenges.
- Appealing to the right identity. Most of us see ourselves as having different roles or identities such as parent, sibling, worker, poor, woman, etc. We may make different choices in the same situation when we consider our different “identities.”
- Short-term timeframe. Getting something in the short-term is much more powerful than waiting for a future pay-off.
- Mental accounting. This happens when we compartmentalize money into separate categories. We have different tendencies to save or spend from different mental accounts. We might be good about not spending the rent money, but will blow “found” money on a night out.
- Lotteries. For many people there is something exciting about a chance to win, especially if it’s a big potential payoff. It’s interesting that some people may respond more to lottery-style bonuses than if the company provides matching funds.
- Influence of Peers. People are more influenced by peers than by “experts.” This means information discussed in small groups is more effective than one-on-one meetings. Peer pressure, in a positive way, can help us learn from others and change our behaviors when we know other people have done so too.
- The best of intentions. Most of us know that long-term goals are important, but what’s happening right in front of us is quite powerful. It may be hard to save money when the local department store is having yet another big sale!
- Mental load. In an unfamiliar, uncomfortable or stressful situation we have fewer mental capabilities to process information, so we don’t necessarily make the best decisions. We become more influenced by the situation rather than our knowledge and experience.
Michigan State University Extension offers solutions to these behavioral puzzles. We can overcome the identity challenge if we set money goals. Putting them in writing and posting them on the refrigerator or bathroom mirror can help us focus on what’s important rather than be influenced by a night out with friends or what our extended family says we should do. Creating a written spending plan and reviewing it weekly can help us remember that it’s important to enjoy today but also to take action to reach our long-term goals. A written spending plan makes it easier to have a positive plan for “found money,” be choosy about how we spend our “fun money” and remind us that it is effective even if we just take small steps toward our financial goals. Taking a money management class goes a long way to gaining practical knowledge from peers. And when we are simply overwhelmed by too many choices or are feeling pressured, we can say “I’ll have to think about it” or walk away and take a breath.