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Personal Finance Psychology

Posted By Jim On 04/23/2008 @ 7:54 am In Debt | 12 Comments

“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 [3]

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 [4]. 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 [5], 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.


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[1] Tweet: http://twitter.com/share

[2] Email: mailto:?subject=http://www.bargaineering.com/articles/personal-finance-psychology.html

[3] Trent of The Simple Dollar: http://www.thesimpledollar.com/2008/04/16/the-simple-dollar-weekly-roundup-things-i-splurge-on-edition/

[4] you should write your goals on your credit cards: http://www.bargaineering.com/articles/curb-spending-by-writing-goals-on-credit-cards.html

[5] Dave Ramsey Is Bad At Math: http://www.fivecentnickel.com/2005/05/09/dave-ramsey-is-bad-at-math/

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