The Psychology of Money
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??????????????? Money is an important part of our everyday lives, no matter who you are, where you live, or what you do. It’s a great tool that can provide enjoyment, security, and fulfillment, but it can also control our behaviors and emotions. Understanding the psychology behind money is an important skill so that you can control your money effectively and not have it control you. In this article, we’ll go through how to look past emotion to make more rational choices, the power of delayed gratification, and how money, happiness, and social dynamics relate to each other. Note that this article does not provide any financial advice, and any financial questions should be brought to a CFA or other qualified professional.
Emotions & Decision Making
??????????????? Have you ever felt exhilarated to receive money, happy to spend it, or anxious seeing it get spent? All these emotions are normal, as we’re all humans, but they can impact our decision making in a negative way. Separating your emotions from your actions is a great way to improve your decision making. For example, buying something expensive that you really want can feel extremely rewarding, as you’ve finally got the thing that you’ve been desiring, and your dopamine receptors are firing. However, this may leave you wanting more of that dopamine. This can cause you to make these purchases more often – even if you don’t necessarily need or want the item as bad as you thought you did. This can lead to a cycle of overspending and dopamine hits, and this can take a toll on your finances.
???????????????The same thing can occur on the opposite side of the spectrum. When money is tight and your finances take a big hit, you can face stress and anxiety, which is a natural reaction to something like this. However, in these moments it’s important to take a step back and take time to feel your emotions before taking any action. Never make financial decisions when you’re experiencing strong emotions, as they can cast a fog over your vision. Instead, create time between the emotional trigger, finding a more balanced mental state, and then evaluating your options and deciding. Guilt and shame over poor financial decisions can also arise, but they often hinder the ability to make constructive changes to your financial behavior. Instead, embrace a non-judgmental attitude, learn from your mistakes, and seek guidance to improve for the future.
??????????????? It’s important to note, however, that emotions are strong, and they can be difficult to recognize when you’re in the thick of it. Let’s explore some quick pointers to help you determine if your emotions are leading you in the wrong direction. Are you feeling particularly euphoric or anxious? Think about why you may be feeling this way – what huge win did you have or what occurred that resulted in this stressor? Write it down on a piece of paper along with what you’re feeling, then step away and try to focus on something else. Once you’ve waited an hour, read that piece of paper again. Were your emotions being helpful in that moment, or do you think you could come up with a clearer approach now?
???????????????Even unrelated events that happen elsewhere can affect your financial decisions, whether that’s a personal conflict or something external. According to Vanguard, researchers have even found correlations between the stock market and the amount of sunshine in a particular day or even a country’s elimination in the World Cup! News headlines are also designed to control your emotions. Have you seen words in a headline like “soaring”, “plummeting”, “broken”, or “destroyed”? These are designed to invoke an emotional response in readers. If you see something like this, it is important to consider the facts and determine for yourself whether you should act, or if doing so could potentially leave you worse off. To take control of your emotions when making decisions, it’s important to ask yourself questions such as:
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The Power of Delayed Gratification
???????????????If you can master it, delayed gratification is a powerful tool that can help you build wealth over time. A classic example of this is the “two cookie kid” scenario. In an experiment, children were given two options: have one cookie now or wait 10 minutes and have two cookies then. Over their lifetimes, the “two cookie kids” on average were shown to be much more successful. This is due to the concept of delayed gratification – putting off what could be enjoyed now and saving it for potentially more useful purposes in the future. All humans have desires, there’s no question about it. If we all had a lot of money, we would all enjoy spending it now on things that we enjoy. This can feel good in the moment, but it also takes away from future opportunities on where to put that wealth. In delaying gratification, one may put aside a purchase of something like a new $1,000 phone and instead invest that money into their retirement fund, which, after 30 years assuming 7% annual growth, yields $7,612! Of course, everyone values present money in different ways, and everyone’s situations are different, so it’s important to balance spending now vs saving for later. Strike a balance that works for you, your lifestyle, and your plans for the future – some are hyper-planners that will do anything to save (take a look at the FIRE movement), and some are more comfortable enjoying things in the present in exchange for a possibly later retirement.
???????????????The total flipside of this is pursuing instant gratification through impulse buying. The world is full of advertisements that play on your emotions or a sense of urgency to force you to make a purchase right here, right now. Making these unplanned purchases every once in a while doesn’t do much harm, but if you let it get out of control, it can seriously derail your financial plans. A great way that you can mitigate impulse buying is when you find out that you want a product, take a few days or a week to decide on whether you really want to make this purchase. This allows you to take the similar approach to before – waiting between emotional trigger, reaching a calmer baseline emotional state, and evaluating for a decision. You’d be surprised to see how often you opt not to make an impulse purchase after evaluating it over a bit of time. That’s a lot of money to be put to use for funding your future!
Money, Happiness, and Social Dynamics
??????????????? The age-old question “does money buy happiness?” has probably entered each of our thoughts at least once. Social media and America’s consumerist society has influenced us more than ever to believe that the answer to this question is “yes”. With fake happiness being posted all over social media, Lamborghinis and designer clothing included, many want to create the impression that they have the perfect life – even if they don’t have the money to back it up. This dynamic is relatively self-fulfilling – as more people show off their lavish lifestyle, even while living on debt and leverage, more people feel as though they’re behind. They try to supplement their lifestyle to “keep up with the Jones’s”, which then creates this feedback loop. Removing yourself from this loop and fighting back the temptation to keep up with this social dynamic can be highly beneficial for your long-term finances, allowing you to enjoy your wealth comfortably in the future.
???????????????To return to the happiness question, the answer is that it does indirectly, but not in the way that one might expect. One that’s not in a secure financial position may stress about making ends meet, which makes them unhappy. However, it’s not a universal truth that having more money always makes you happier. Money buys security, which, in turn, makes people happy. Some elements that make people happy include:
???????????????Money does, in fact, contribute to fulfilling your security needs and autonomy or control over your life. Having enough money to cover these expenses and not have to worry about debt – or even work – will make you happier. However, money is not the end-all-be-all. Money will not fix your relationships, it won’t give you purpose, and it won’t give you a feeling of accomplishment unless you do something meaningful with it and your efforts. Additionally, the law of diminishing returns states that at some point in growing your bank account, your happiness will plateau, meaning more money will cease to do anything for your happiness. One of the most important things to note in terms of happiness and the social dynamics in our society is that comparison is the thief of joy. When scrolling through social media and seeing all these people enjoying their lavish lives, remember to appreciate everything that you have and not what you don’t. To quote Warren Buffet, “There is no reason to risk what you have and need for what you don’t have and don’t need.”
Conclusion
??????????????? Overall, emotions and money play hand in hand. Decision making is much more difficult when you’re overwhelmed with emotions, and while it can be difficult to separate yourself from your emotions, practicing doing so can be very beneficial. Resisting impulse purchases and saving money that you would spend now for the future can set you up for a stable and healthy retirement, especially if you invest your money responsibly. Finally, avoid succumbing to societal pressures to live a lavish life that you can’t afford, and avoid comparing yourself to others and their situations. It’ll be much easier to find happiness if you focus on yourself, your life, and your relationships. To read more on this topic, check out the book The Psychology of Money by Morgan Housel. Remember, this article is not meant to distribute financial advice, and if you have further questions, please seek a CFA or other financial professional.