Many of us have regretted spending money when we shouldn’t have or have found ourselves stressing about our finances. But what are the main characteristics that lead us into being in these situations? And more importantly, what can we do about it?
1. We are poor, tired and worn out
Why would anyone take a payday loan at 1 000% interest? Why buy junk food when it is cheaper to cook at home, or waste R 40 a week on lottery tickets when the money could be used to pay off debt?
The truth is that if you are feeling poor or financially stressed, you are more likely to make bad financial decisions, this is according to a new report from the World Bank. “They borrow too much and save too little.” However, this report does not blame the poor – it says the constant, day-to-day hard choices associated with poverty is quite taxing an individual’s psychological and social resources, which turn them into bad decision-makers.
Additionally, research from 2013 by academics Sendhil Mullainathan and Eldar Shafir, shows that that being preoccupied with money problems is equivalent to a loss of 13 IQ points, losing an entire night’s sleep or being a chronic alcoholic. This could explain why poorer people are more likely to make bad financial decisions.
2. We fail the marshmallow test
In a famous 1960s psychological experiment by Stanford University, children were filmed being offered one marshmallow immediately or two later on. The researchers deliberately left the room for 15 minutes, leaving the children alone as they squirmed and struggled to defer their instant desires.
On average, the children lasted 3 minutes before eating the marshmallow. About About one in three children lasted the full 15 minutes and were rewarded with two marshmallows.
Many years later, Walter Mischel (the professor who ran the experiment) found that the children who were unable to wait were the ones most prone to poor academic achievement and were less likely to plan ahead.
Further studies suggest that it is not innate IQ or intelligence that matters, but self-control. The crucial skill of those who deferred grabbing the marshmallows was not that they did not want to eat them, but that they managed to distract themselves from their desire.
The financial lesson from Mischel’s research is that if you are tempted to splurge on your credit card, you must avoid thinking about the thing you want in the first place.
3. We are no good at maths
A coke and a sweet cost R 10,50 in total. The coke costs R 10 more than the sweet. How much does the sweet cost?
If you’re like most people, you’ll say the sweet costs 50c and that the coke costs R 10. However, the correct answer is the coke is R10,25 and the sweet is 25c. It’s a typical example of how people wrongly assess numeric information. This results into people making incorrect financial decisions. It’s also why retailers use multiple discount offers that confuse shoppers into spending more than they were expecting.
Dealing with our finances can be complicated. Unsurprisingly, we cannot hold a complete picture of our financial situation in our heads all the time. Our solution is to divide our finances and deal with each aspect separately.
Many people tend to borrow on credit cards while elsewhere they have a pot of savings. Economists say that this makes no sense, as you should rather consider your overall net position and manage accordingly however, this is not the way we think. This is why many people find it beneficial to speak to a financial professional.
4. We can’t cope with choice and complexity
Given that decisions are driven by comparing all the available options, having too many options makes it difficult to make a choice.
Many studies have shown that when we are given many options we struggle to make the right decision. This is also true for financial decisions, and the most common coping mechanism is to make no decision at all. This leaves people sitting with the same financial problems month after month.
Financial professionals aim to provide clarity to consumers on their financial situation and give recommendations to the best possible solution.
5. We do what everyone else is doing
When forced to make a decision for which there is no precedent, our go-to solution is to look at what other people are doing. The herd mentality makes an awful lot of sense in many situations, but not when it comes to our finances.
When people are choosing where to invest, they won’t systematically think about all the options. Instead, they will consider what other people are investing in.
Similarly, if everyone around us is borrowing on credit cards and putting off paying into a pension, we take comfort from the fact we are doing the same things as everyone else. We don’t stop to consider whether everyone else is right.
Your finances are personal and your situation is unique. It is best to speak to a professional who will spend time in understanding your financial situation and offer objective advice.