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| Money makes us do dumb things. It plays tricks with our brains. One thing can protect you: a massive wall of cash. Have one? We'll help you build one |
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Money Truth #2 Thinking too much about money will make you poorer Consider the madness of stashing cash to pay monthly expenses. Madness? "Think about it: It's irrational to deduct cash at the beginning of the month," says Dan Ariely, Ph.D., a professor of psychology and behavioral economics at Duke University and the author of The Upside of Irrationality. "Logic says you should decide how much to save only when you know what expenses you've had—at the end of the month." But we all know that unless we treat savings as a monthly expense, we'll never save a dime. Consumption rules, remember? Another way our rational brain sabotages us: It's hard to think about the implications of our current spending on our future financial health. This is the "opportunity cost" of money. "Imagine you're going to buy a car," says Ariely, "and I ask you, 'What would you not be able to do in the future if you buy that car?' Our research team went to a car dealership and asked people that question, and most were shocked. They never thought there might be something they'd have to give up later." Your money move "We deal all day in our money, so we think we're really good at it," says Ariely. "But the reality is, we're really bad at it." Signing up for direct deposit and automating savings and bill payments—basically, removing as much money from your day-to-day thinking as possible—are great ways to save. It's easy, the transactions are invisible, and it works: Fidelity's research shows that when employees are auto-enrolled in a company's 401(k) plan, nine out of 10 stay with it. Money Truth #3 Your bank balance tricks you Another basic economic theory, the wealth effect, further explains our nonsaving tendencies. It's a simple concept: The wealthier you feel, the more you spend and the less you save. According to Jay Zagorsky, Ph.D., an economics researcher at Ohio State University, this effect has played a role in each of the 10 recessions since World War II. As economic conditions deteriorated, people felt less wealthy, so they scaled back their spending. Savings rates rose during and after these downturns, but then retreated as financial conditions improved. The one exception was after the 1990 recession; savings rates improved only minimally, because the stock market bubble began and made everyone feel so wealthy that savings dropped from nearly 8 percent to about 3 percent between 1992 and 2000. "This is classic herd mentality," says Kathleen Gurney, Ph.D., founder and CEO of Financial Psychology Corporation and the author of Your Money Personality: What It Is and How You Can Profit from It. "If we see a lot of people doing it, then we perceive it to be safer than it is." Indeed. As the bruises heal from our most recent fiscal ass-kicking, look what's happening: Commerce Department numbers indicate that in mid-2007—before the recession—our savings rate was just under 2 percent. Then, in the first half of 2009 when things were arguably at their worst, it spiked to just over 7 percent. Now that conditions are slowly improving...voila! Savings rates have declined. Your money move Zap the wealth effect, says Heath. Increase the amount you save whenever new money comes your way, and keep the formula simple and sacrosanct: If your company gives you a bonus, half of it goes into savings the day you receive it. It's your new rule—not something to think about. If you receive an annual raise, have half of that raise direct-deposited into your savings. By stashing just half, you still feel the bump in income. Money Truth #4 You put the dope in dopamine Check out the current tone of the investment industry: Online brokers hard-sell us with low-cost Internet trades guaranteed to be transacted in seconds. The message: Trade more, trade faster. Jim Cramer, host of CNBC's Mad Money, encourages viewers to "double down"—a blackjack phrase—on stocks he believes are nearing their lowest price. Investment banking firm Goldman Sachs has been accused of selling financial products to clients while simultaneously betting against those products with company cash. Investing becomes betting. Why are we so susceptible to this? "Risk alters our brain chemistry," says Gurney. "The merest thought of making money is energizing, which stimulates production of dopamine, the gratification chemical. The more dopamine we produce, the more primitive our behavior becomes and the more difficult we find it to make rational decisions. That's why you see gamblers who can't walk away from the table whether they've won or lost." Gurney's research, which identifies nine distinct money personalities, shows that men are more motivated by power than women are, and that they associate risk with the ability to become wealthier and more powerful. "The two money personalities that take the highest risk, the high rollers and the entrepreneurs," Gurney says, "are the most male-dominated profiles." Now think about the opposite of high-risk finance. Being a good financial citizen requires that you first build that great wall of cash. Saving 6 months of expenses, which for most of us can be anywhere from $20,000 to $50,000, seems incredibly difficult. So let's say you start small and automate $35 into a savings account every 2 weeks. And your brain will be asking, Where's the damn dopamine rush? "Putting away a little money each month will feel pointless at first," says Wedeman. "There's no juice in it. You're thinking, 'I could've spent that $35 on a good case of beer.' " And even if you do put away, say, $30,000 in a savings account or money market fund, it will still just be cash sitting there. Untouched. Lonely. A warm swimming pool full of naked women that you cannot dive into. And then you start to think in ways that produce dopamine...put the money into the stock market, get some chips in the game. Even though this money exists strictly to protect you from unexpected expenses, to keep you out of debt. "It takes deep discipline not just to save cash," says Bodie, "but to leave it the hell alone." Your money move Save your dopamine for fantasy football. Accept that your best financial work won't feel very good. "What's hard is tolerating all the middle steps," says Wedeman, "like when you're saving but still don't have a lot of money in the bank. It's like sticking to the diet when you're hungry but still fat." Use your brain's tendencies to your advantage here. Ariely points out a concept known as the prospect theory. "Your brain is designed to estimate changes in wealth rather than absolute levels. It makes sense—who takes pleasure in observing something that never changes? So focus on the positive changes you see." |
