For being such a dollars and cents type of issue, personal finance sure has a lot of psychology involved, doesn’t it? If it weren’t for psychology, ideas like Dave Ramsey’s debt snowball method would be dead on arrival. The debt snowball works because it taps into human psychology, not mathematics. Paying off your smallest debt first isn’t mathematically optimal. It works because after you pay off the smallest debt, you get a sense of accomplishment, a boost of morale, and you are more likely to continue the project. You apply your smallest payment to the next smallest debt and continue until you’re debt free. You pay a little more in interest but you are rewarded with actually finishing because the snowball motivates you to keep at it.
That led me to wonder what other bits of personal finance advice tap into human psychology for success?
Using Cash Only
There’s a reason why casinos use chips to represent money, it’s because chips don’t look like real money. When you swipe your credit card, it doesn’t feel like you’re spending money. When you pull a ten dollar bill out of your pocket, it feels very real. This psychological difference is the reason why so many people experience success spending less when they spend only in cash.
Cash forces you to plan ahead because you can’t spend more than the money in your pocket. Cash forces you to pay for 100% of your purchase right this moment, not 0% now and 5% each month for the next ten years because of interest. Cash forces you to make that tradeoff immediately – do I want the money for later or do I really want to buy this?
Create Barriers to Spending
The best example of how to create a barrier to spending is freezing your credit card in a block ice. People who have gone to cash only usually apply this technique to their credit card because they want to force a delay in spending. If you want to buy something with a credit card, you’ll have to wait until the ice thaws and you can get to your card. It’s a clever idea because it adds two important barriers to the spending process:
If you make it harder to spend money, you’re less likely to do it. There’s a reason why so many online stores want to store your credit card information for later use. They tell you it’s a good idea because then you won’t have to fish for your credit card next time, which is very true. However, it removes one of the biggest barriers to the buying process – paying! If you had to wait a few hours (for the ice to melt) before every purchase, chances are you would spend less and that’s what I’m driving at. Create barriers to spending and you will spend less!
Companies spend millions of dollars a year on branding and people seem to enjoy the “better” brands because of it. Back in college, we used to fill our one glass bottle of Skyy Vodka with Vladimir, which came in a plastic jug. Why? Branding. The stuff out of the bottle of Vladimir tasted awful, but somehow when it was poured out of the dark blue bottle it was magically delicious. So why not buy one box of the brand named stuff and simply refill it with generic whenever you’re finished with it?
That first bit was a little tongue and cheek but I think the spirit of the idea is very true. In the last year or two, with the recession, a lot of people have gone to buying generic versions of products because they were cheaper. As the economy recovers, people are sticking with those choices because they’ve learned that the generic versions are just as good. I don’t think anyone would believe Vladimir was the same as Skyy (unless they were stupid college kids who just didn’t care), but how different is a generic pasta sauce vs. a branded one? Probably not as much as the price difference.
Here’s one actual secret – it’s not uncommon for a brand name company to produce the generic product in the first place. So you could be buying the same, or similar, product for much less.
This idea is most powerful whenever you’re talking about over-the-counter brand name drugs. The active ingredient in most drugs can be purchased in a generic form. Loratadine is the active ingredient in Claritin and you can it for a fraction of the cost of brand name Claritin.
Set Up Automatic Savings
Set it and forget it. This idea is the main thrust behind David Bach’s Automatic Millionaire and it’s a powerful idea. By putting your savings on autopilot, you will likely accumulate more savings than if you tried to remember each month. It’s less about psychology and more a testament of how busy we keep ourselves but the idea still holds true. Contact your employer’s HR department to set up an automatic 401(k) contribution, set up an automatic deduction from your checking account to a high yield savings account  or a broker.
By making your savings automatic, you let your forgetfulness work to you advantage. You’d probably rather forget and be saving than forget and not be saving. 🙂
Visualize or Photograph Your Goals
Ever wonder why there are an inordinate number of beer and pizza commercials during football games? Or how about restaurant ads right before dinner? It’s because the advertisers understand the idea of priming . Priming is when earlier stimulus influences our response to later stimulus. In the case of beer commercials during football games, Budweiser and Miller want you to think of them the next time you are thinking about football. Papa Johns wants you to savor better ingredients, better pizza… perhaps at half time.
If you have any financial goals, rather than have them be reflected in just a number – such as the savings account balance for your down payment, take a photo of your dream house and out it somewhere prominent. Put it on your credit cards. Write it on your checkbook. Set it as your computer background. If you’re saving for your kid’s college education, put a picture of that little critter’s face on your credit card so you’re reminded of that goal every single time it matters.
Are there other psychological money tricks that work to help you save more, spend less, and otherwise get closer to your financial goals?
(Photo: epac_island )