How to make your money biases work for you
The way our brains work can cost us a lot of money. But some of our mental quirks can be turned to our advantage.
We can try to be more rational, but sometimes it makes sense to exploit our faulty wiring instead. Here are three money biases that you could put to work for yourself:
Mental accounting
Money is fungible, which means every dollar has the same value regardless of how we get it or store it. But our brains didn’t get that memo, so we treat different types of money differently. We’re tempted to splurge with windfalls, for example, or to be more careful spending cash than using credit.
You can turn this mental accounting to good use by creating multiple savings accounts, each labeled with your goal for the money.
For example, you could create accounts called “vacation,” “car repair fund,” “home down payment” and so on. Online banks and credit unions typically make this easy by allowing you to create and name numerous subaccounts without minimum balance requirements or fees.
‘End-of-history illusion’
Think of the person you were a decade ago — what you thought was important, what you liked and disliked, how you behaved. If you’re like most people, you’ve changed, but you also probably think that the person you are today is pretty much who you’ll be from now on.
Regardless of their age, adults consistently underestimate how much they’ll change in the future, according to research by psychologists Jordi Quoidbach, Daniel T. Gilbert and Timothy D. Wilson, who dubbed this phenomenon the “end of history illusion.”
Hyperbolic discounting
Our hard-wired preference for short-term payoffs, even when we would get more by waiting, is known as “hyperbolic discounting.”
Behavioral economists Richard H. Thaler and Shlomo Benartzi designed a “Save More Tomorrow” intervention where people committed to saving a portion of future raises. The economists figured opportunities to save future income would be considered more attractive than giving up current income. They were right: Retirement plan participation and contribution rates rose at the companies that tried this approach.
This column was provided to The Associated Press by the personal finance website NerdWallet.