Posts Tagged ‘Behavioral Economics’

Follow Your Money For Answers

Monday, February 27th, 2012

 

 

According to the Bureau of Labor Statistics, more than half of the money we spend goes to housing and transportation. Reading about the breakdown of consumer spending, started me wondering…

 

1)      Why do we naturally bristle at the thought of saving money?

2)      Why does the discipline of wise money management overwhelm us?

3)      Why are we so great at finagling funds for fun, funky and frivolous stuff?

 

If you can relate (and honestly, who can’t?), you might be interested in knowing there is quite a plethora of documented theory that speaks to these questions and more published under “Behavioral Economics” and “Behavioral Finance”.  In simple terms, these theories address how social, cognitive and emotional factors affect our economic decisions. If you care to read historical timelines and academy, find them here: Wikipedia, AOBF and Neuroeconomics – yes, there is such a thing as Neuroeconomics – it is a focus for explaining “human decision making”.

 

 

Mental Accounting

 

Investopedia.com offers insights as to why we do and don’t spend certain resources under the auspice of, “Mental Accounting”. This concept suggests that much can be learned from the way we separate and allocate our money.

 

Mental Accounting is a subjective view of money. For example, when we earmark paychecks for monthly living expenses but think of “found” or unexpected money, such as tax refunds and lottery winnings, as money that can be freely spent, it is a subjective allocation.

 

Conversely, unemotional and logical money management does not recognize a difference between a $2,000 paycheck and a $2,000 winning lottery ticket – $2,000 dollars is $2,000 dollars regardless of source. (See the full tutorial here.)

 

Follow the Money

 

How can we nip Mental Accounting in the bud? Try following your money around for the next month in words – literally. If you’ve ever dieted, you know how helpful keeping a food diary is. No one likes doing them, but it is the most telling tool you can give yourself. Write down what you spend, allocate, and save every day – what, where, and why you spent it too. This includes the checks you write on your monthly bills.

 

At the end of the month you will be able to detect the way you think about money and possibly find some red flags you hadn’t seen (or thought of as such) before. For example, are you holding onto low interest bearing accounts and making high interest rate credit card payments? Could you pay off a small debt right away by using some of your ‘fun’ money? Are you keeping spare change in a can or buying dollar scratch offs?

 

Brace yourself, all those trips to Starbucks, Subway and Super K may just rise up and slap you silly across the face. Good luck.

 

Kurt Rusch  CLU,ChFC