There is a lot of overlap between psychology and economics, because both focus on certain aspects of how we make decisions.
When I look at the current state of our economy – especially growing personal debt and low credit scores among consumers – I often wonder what psychological factors are driving this behavior.
A recent study published in Psychological Science discovered a key predictor of low credit – impatience. Researchers from Stanford University recruited 437 individuals from low-to-moderate income families; after conducting a questionnaire, and getting permission to access the participants’ credit scores, they found that individuals with low credit also tended to be more impatient and impulsive.
Impatience is our tendency to choose immediate rewards rather than wait for a larger reward in the future. It reflects a need for short-term gratification, as well as an inability to see and plan for the future.
For example, would you rather have a million dollars right now or a penny doubled everyday for 30 days? At first, the million dollars seems like the most tempting choice. However, when you do the math, a penny doubled everyday for 30 days actually totals $5,368,709.12 – over five times more the first option.
As long as you don’t have an immediate need for cash, the best option is to go with the penny doubling everyday for 30 days. However, to correctly make this choice, you would need to be able to delay your need for short-term gratification – a million dollars right now sounds very tempting, but holding out a bit longer will lead to a much larger reward in the end.
We make similar decisions in everyday life. In the economic world, we often need to save up and wait for “large rewards” – a new car, home, TV, college tuition, etc. But instead of taking the time and patience to save our money, we end up making short-term, more immediate decisions – especially risky loans, which we may not be able to pay for in the future.
It’s natural to strive for immediate satisfaction of our wants and needs – in many ways, this drive has helped us survive as a species. The problem is when these short-term gains actually end up leading to higher costs in the long-term. Psychologists say that this kind of cost-benefit analysis is at the root of low credit scores and high personal debt.
Here are three key tips for improving your mental battle against impulsive spending:
1. Imagine yourself in the future.
One study published in The Journal of Consumer Research has suggested that by imaging our future self we can curb present spending and save more for the future.
“The willingness to forego money now and wait for future benefits is strongly affected by how connected we feel to our future self, who will ultimately benefit from the resources we save,” writes Daniel M. Bartels (Columbia Business School) and Oleg Urminsky (University of Chicago).
If we can place ourselves in a bird’s eye view of the future (especially when making financial decisions), we can often become better planners for our future retirement by seeing the “bigger picture” of our habits, and not just focusing on the “heat of the moment.”
2. Avoid common spending biases.
Many of us hold cognitive biases that hurt our wallets. Hopefully by being more aware of some of these irrational tendencies we can avoid making these mistakes in the future:
Status quo: We stick to buying what we know instead of pursuing alternatives.
Relativity trap: We notice a product is on sale 20% so we feel more compelled to buy it even though we never really needed the product in the first place.
Sunk cost effect: Instead of cutting our losses short, we often hold onto poor investments hoping that they will bounce back (except they don’t).
FREE!: We can be very allured to anything that is “FREE!” and we often make irrational spending decisions to get something for free (even if we end up buying something we could otherwise live without).
Restraint bias: Humans tend to overestimate their self-control regarding spending. One thing we can do is avoid getting ourselves in tempting situations or environments that encourage us to buy something new. Going to the mall every weekend, even just to “look around,” can end up becoming a spending spree.
Post-purchase rationalization: This bias describes our tendency to backwards rationalize our decisions after we’ve committed to them. Sometimes marketers use “Money Back Guarantees” knowing that instead of regretting a purchase we will usually find a way to justify it to ourselves. Don’t be afraid to return things that don’t meet your expectations.
3. Practice meditation to help “disengage” from impulsive spending.
Impulsive spending is often automatic and unconscious, but practicing meditation on a regular basis can be a great way to infuse more consciousness into our daily decision-making.
The STOP technique is particularly useful with spending because it can be applied to a wide-range of different settings.
It works by “stopping” what you are doing (whatever it may be, such as buying an expensive pair of jeans at a store), and then doing some “brief reflection” by asking yourself questions like “What am I thinking? What am I feeling? What am I doing?” After answering these simple questions, you will often have an easier time determining if you really want to purchase what you are thinking about purchasing.
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