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This is the first of a fourteen-part series that explores the core tenets of Get Rich Slowly.
I had a group of old high-school friends over to the house last weekend. As the daylight faded and the cool of the evening settled, we sat around a blazing fire talking about life. We shared the good things we’ve done over the past twenty years — and we shared the bad. Inevitably, the conversation turned to money.
One woman confessed that she’s a shopaholic. When she feels stressed, she buys things. To prevent her husband from finding out, she’s the one who pays the bills.
Another woman has more clothes than she will ever wear. Her closets are packed so full that she’s begun to pile new purchases on the floor — but still she buys more.
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One of my friends admitted that he’s sunk thousands of dollars into online video games. After his divorce, he spent years addicted to his computer. (He’s now turning things around: He quit gaming cold-turkey and is re-discovering friends and exercise.)
I told my own story of how I used to buy books and clothes and compact discs compulsively. “I’d bring them home and never use them,” I said. “I just liked the act of buying. It gave me a sense of power, I guess.”
Each of us had a story about how we’d done dumb things with money. In every instance, these dumb things were the product of some psychological or emotional impulse. We weren’t acting rationally. We’re smart folks — when we were in high school together, we were in the college-prep classes together — and we understand the mathematics of our choices, but we make them anyhow. Why?
Because smart money management is more about mind than it is about math.
The psychology of money
For years, the “expert” advice on personal finance has assumed that we act like machines, that we will always choose the mathematically optimal option. I’ve read countless personal finance books filled with advice that is technically correct, but which forgets the role our minds play in making financial decisions.
When discussing this notion — that financial success is more often influenced by personal psychology than by mathematical ability — I frequently cite Dave Ramsey’s debt snowball. It’s the perfect example of what I mean.
Critics of Ramsey are quick to point out that the math of his method doesn’t make sense. Going strictly by the numbers, it’s better to pay down debt by starting with the obligation that has the highest interest rate. The critics are right, of course, but they miss the point. In most cases, if we were being rational, we wouldn’t have accumulated the debt in the first place. Most of the time, debt isn’t a math problem — it’s a psychological problem. Because of that, Ramsey’s method — pay off the lowest balances first — makes more sense. It allows quick wins, which provide positive reinforcement, which provides a motivation to continue.
Here are some of the many other ways in which our minds play a role in money management:
Any time we loan money to family or friends, emotion plays a role. And inheritances? In the past year, I’ve had three people tell me nightmare stories about families that have disintegrated while fighting over a parent’s estate. These are psychological and emotional battles, not battles about math.
Marketing (and advertising) is the science of persuasion. It purposefully influences our spending habits — even if we think it doesn’t. When we reduce our exposure to advertising, it’s easier to spend less.
I am in constant awe of what parents spend on their children. They want what’s best for their kids, and most of them aren’t afraid to pay for it. But it’s not rational to buy clothes at Baby Gap instead of at Goodwill.
A lot of financial planning is about teaching the client to take emotion out of investing. Too many people make investment decisions based on psychological reactions to the economy and the stock market. It’s these emotional reactions that cause people to buy high and sell low.
Every financial goal we set is based on our personal psychology, on emotion.
There’s a burgeoning body of research that explores the many ways in which money management is more mental than mathematical. “Behavioral finance” and “behavioral economics” are explored in books like Why Smart People Make Big Money Mistakes — and How to Correct Them [my review], Why Smart People Do Stupid Things With Money, Predictably Irrational, Nudge, and Your Money and Your Brain.
Take back your brain
We can never completely remove the emotional and psychological aspects of money management. Nor do I think we ought to. We’re humans, not robots. But I do think it’s important for us to reduce the negative emotional financial decisions as much as possible. Here are some of the best ways that I have learned to combat poor choices — to take back my brain:
Reduce exposure to advertising. Many people believe they’re unaffected by advertising. Many people are wrong. As much as you can, avoid advertising. Watch less television (or watch it in a way that cuts out commercials). Skip magazine ads. Use an adblocker for your browser. The less advertising you see, the less you’ll be persuaded to buy things you do not need.
Avoid temptation. When I was paying off my debt and trying to reduce my spending, I forced myself to stay away from book stores and comic shops. I knew that I lacked discipline. Rather than put myself in the path of temptation, I steered completely clear of it. If you’re tempted at malls, stay away from malls. If you often succumb to peer pressure, don’t go out for drinks with your friends. Stay away from the things that tempt you.
Automate. One of the best ways to trick your mind is to simply take it out of the equation. If you find it difficult to make smart financial choices, remove the choice. Sign up for auto-billpay. Set up an automatic monthly transfer from your checking account to your savings account. If you have access to an employer-sponsored retirement plan, take advantage of it. When you make things automatic, you cannot be sabotaged by emotion or psychology.
Practice mindfulness. When you’re tempted to make a purchase, pause. Take thirty seconds to ask yourself if you truly need the thing you’re about to buy. If it’s a big purchase, force yourself to wait thirty days. Track every penny you spend so that you become aware of your weaknesses.
Read. Better education has helped me fight some of my mental flaws. The more I read about stock market investing, for example, the more convinced I am that making regular investments into index funds is the only way that I’m going to be a successful investor. It takes the emotion out of the equation.
I’m not sure what will happen with the friends I saw last weekend. Maybe some of them will continue to make the same financial mistakes. Maybe some of them will turn things around.
But I do know this: The answers to their problems will not come from a better understanding of compound interest or another explanation that it’s important to spend less than you earn.
While these concepts are important, they’re purely mathematical. In order for my friends to manage their money, they need to go beyond math — they need to master their minds.