Personal Finance Psychology

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“I usually keep my card wrapped in a picture of my children to remind me of why I shouldn’t spend … ”
                                             — Trent of The Simple Dollar

If you think money is about dollar and cents and things you can hold in your house or your hand, you’re wrong. Personal finance may seem like it’s all about the numbers, where you have to spend less than you earn, where you have to save up an emergency fund, where you have to invest in the stock market and get your 10% return; but the truth of the matter is that personal finance is more about psychology than it is about mathematics. Everyone knows that you have to spend less than you earn, no one is so disconnected or so poorly educated that they don’t realize how basic math works. It’s like physical fitness, we all know what we’re supposed to do, we just have difficulty remember to do it.

Trent made the above quoted statement in response to my post about how you should write your goals on your credit cards. My tip was a simple reminder, his was a simple reminder packed with the power of psychology. You can easily write the goal on your credit card and then dismiss it when you need to spend. Dismissing a picture of your children, the reason you live, breathe, and work every single day… dismissing that would take a Herculean effort. But it works. Trent knows he shouldn’t splurge on food or kitchen tools or video games, JD knows he shouldn’t splurge on comic books, and I know I shouldn’t splurge on vacations. Slap a picture on it, of either your kids or your cats, and it drives that point home like a jackhammer.

If you think Dave Ramsey Is Bad At Math, you’re not alone. You’re also right. Dave Ramsey’s Snowball debt busting methodology is mathematically suboptimal. For those unfamiliar with it, you essentially pay off your smaller debt amounts first, then roll those payments into larger and larger debts. The payments “snowball” and you are also rewarded with positive feelings about knocking out the smaller debts. It’s suboptimal because you would save more money by paying off the highest interest rate debts first, but you lose the psychological benefit of kicking one of those debts in the butt. While suboptimal mathematically, for many it is the optimal solution because it helps them overcome their debt. It may not be smart math, but it’s smart psychology.

The next time you have difficulty with something personal finance, be it spending less than you earn or saving towards something, try some psychological tricks and you may find that it works out better in the long run.

{ 12 comments, please add your thoughts now! }

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12 Responses to “Personal Finance Psychology”

  1. Rick Morley says:

    I’m personally completely unaffected by all of the psychology “feel-good” personal finance. I don’t do what “feels” the best. I do what I know is mathematically the best.

    I guess it’s different for each person, though.

  2. saladdin says:

    “I do what I know is mathematically the best.”
    If others went by this then no one would have kids.

    Sorry Ric, just don’t buy it, nobody is 100% math or 100% emotion. It goes against human nature. We all use parts of both, except the weighting differs.


  3. jim says:

    I disagree saladdin, Vulcans are 100% math. 🙂

  4. Darin H says:

    About 7 years ago, I had about $6000 in credit card debt and about $6000 left on a car loan. I kept trying to pay off the credit card first because it was the higher interest rate. I’d pay $500 and then put $200 back on it, pay $800 and put $300 back on it. I kept trying to pay so much on the credit card but then I would have the feeling that I had room on the card to use. I switched over to paying extra on my car loan and just the minimum on the CC. It worked for me, I wouldn’t spend extra on the CC and you can’t increase the balance on a car loan 🙂 I had the car paid off in 8 months and the CC a few months later. That was also the last time I ever had credit card debt.

  5. Right on the money, Jim (if you can excuse the pun). I’m doing the snowball thing and it seems to be working just fine. My biggest problem is the stuff that “life” throws at me (unexpected dental bills, a 30 foot tree that topples over from a big rain storm). The emotional content helps me stay focused.

  6. MICHELE says:

    I don’t believe for one minute that Dave Ramsey believes that his snowball method is saving more money than the pay highest interest rate first method. There is a lot to be said for the psychological value of paying off and eliminating debts. If you have two credit cards, one at 30% interest that has $17000 on it, and one at 19% that has $1700 on it, you will be paying for a long time before you see any result if you pay the 17000 card first. Discouragement sets in, and you find yourself locked in a cycle of charging and never getting anywhere.

    The part of this formula that seems to always be overlooked is the main thing that makes this plan work. You not only have to agressively attack your debts and pay them off, you have to stop using the cards as well.

    That is a tough one for a lot of folks to swallow. I love reading comments from people who say “I pay off my balance every month”. Thats all well and good but explain to me why you have a credit card at all if thats the case. DR is not out there for those people. He is out there for people who have gotten out of control, people who see no light at the end of the tunnel and he gives them hope to actually pay off credit cards in less than 100 years and more important, to learn to stay out of debt.

    I don’t agree 100% with what he says, but he is going in the right direction.

  7. Jim,
    I have to disagree with you on this one. Vulcans aren’t 100% math. They’re some proportion math, some proportion emotion, similar to humans — but they train themselves to suppress the emotion piece and to act only on the math piece.


    The post? Oh. I agree with the post. I endorse psychological tricks. We use them in a lot of places, including in automatic saving and investing. For us, when the money leaves our accounts and goes into our pre-planned investments, it’s as if we never had it. So we feel like we have somewhat less money than we do, and I believe that on a subconscious level, we curb our spending a bit more.

  8. Kirk says:

    Dave Ramsey knows the psychology behind the snowball method. You build momentum, emotionally, when you eliminate a monthly payment. It works in other areas of life as well.

    However, I try to frame it different for folks in debt. I attempt to get them to pay the highest debt first. So I change the psychological effect. I have them focus on net worth. We figure out what their current net worth is (often it is negative) and we pay down the highest rated debt first. This will increase net worth the quickest. If they focus on building wealth, it really helps. It is a motivator to see their net worth grow. The faster it grows, the more they want to grow it…momentum at play.

  9. Personal Finance is definitely psychological.

    Most of us are not saving enough for our retirement. Yet we :

    1. still take vacations

    2. spend more than we should on “stuff”

    3. Take a HELOC to renovate the home.

    4. don’t stick to our investment plan.

    Come to think of it, maybe the route to real personal finance success is to get really wealthy! And FAST!

  10. Suzy says:

    I believe to tackle your debts, the snowball method is great. It’s working for us and I would recommend it. If you start to feel good about paying down your debts (which requires you spend less money) you will continue on the path. The one thing that I find discouraging about Dave Ramsey is all the callers on his Fox Business Channel show have $175,000 mortgages. If you live in expensive real estate markets, like San Diego, you feel like you will never crack the huge nut of debt you have built up!

  11. This is a great tip. I think for some it can be nearly impossible to get and keep finances on track without some ‘coping mechanism’ that is based on an individual’s personality. My coworkers have photos up of their kids to remind them why they do it. The photo around the credit card is a great idea. And for those of us who don’t have kids, writing goals on the card is an excellent idea! I have linked to this article from my blog. Great info here!

  12. roberta says:

    I totally agree with this quote, we know what to do but we need to be psychologically tricked into the method.

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