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Why Even Smart People Have Money Problems: 3 Reasons
12.08.2024 10:20
Updated: 28.09.2024 01:32
In today's world, financial literacy is becoming an increasingly important skill.
However, even smart and educated people often fall into money traps. Let's figure out why this happens and how to avoid it.
Money Illusion: When Numbers Deceive
One of the most common problems is the so-called "money illusion".
The point is that we often forget to take into account the real purchasing power of money.
Imagine this situation: you received a 5% salary increase, and you feel like you can now afford more.
But if inflation was 7%, your options were actually reduced. However, our brains tend to focus on absolute numbers, ignoring their real value.
This problem was described back in 1928 by economist Irving Fisher. He noted that people often do not understand how the value of money changes over time. Later, in 1997, psychologists conducted an experiment that clearly demonstrated the effect of the money illusion.
Participants were told about two workers with the same starting salary. The first one's salary increased by 2% with zero inflation, the second one's salary increased by 5% with 4% inflation.
Although the first worker's position turned out to be more economically advantageous, most participants believed that the second worker, the one with the nominally higher increase, was happier.
How to fight money illusion? It is important to learn to think in terms of the real value of money.
When planning your budget, consider not only nominal amounts, but also the inflation rate. Keep track of your expenses, this will help you assess your financial capabilities more soberly.
Hyperbolic Devaluation: Why We Choose Less, But Now
Another common trap is the tendency to prefer immediate rewards to delayed ones, even if they are smaller. Psychologists call this phenomenon "hyperbolic discounting."
Let's say you are offered a choice: to receive 1000 rubles today or 1500 in a month. Many will choose the first option, although it is rationally more profitable to wait. But when it comes to a more distant future, we become more rational. If the choice is between 1000 rubles in a year or 1500 in a year and a month, most will choose the larger amount.
This cognitive bias affects more than just financial decisions. It explains why people find it so hard to stick to a diet or quit smoking—instant gratification seems more valuable than the long-term health benefits.
Some scientists attribute this feature to evolution. Our ancestors found it more advantageous to seize opportunities immediately, since the future was too uncertain.
To overcome this trap, try the following strategies.
1. Automate your savings. Set up automatic deductions of part of your salary to a savings account.
2. Use self-restraint methods. For example, set a limit on daily spending.
3. Visualize the future. Imagine how your decisions today will affect your life in a year, five years.
The denomination effect: why small change slips through your fingers
The third common problem is the so-called denomination effect. The essence of it is that we treat money differently depending on the denomination of the bills.
Large bills seem more valuable to us, it's a pity to spend them. And we spend small money easily, often without thinking. Because of this, it may turn out that we spend more on small purchases in total than we would have spent on one large one.
This effect was described by scientists in 2009. During the experiment, people were given the same amount of money either in one large bill or in several small bills. Those who received a large bill were more likely to refrain from spending.
Interestingly, this effect is stronger in countries where cash is used more often. For example, in China, the difference in behavior between people who received large or small bills was especially noticeable.
Another manifestation of this effect is our tendency to consider a purchase more profitable if the price is broken down into small payments. A subscription for "30 rubles a day" seems more attractive than "10,950 rubles a year," even though it is the same amount.
How to combat this effect? Here are some tips.
1. Try not to carry small change with you. It is psychologically more difficult to part with a large bill.
2. Keep track of all your expenses, including small ones. This will help you realize how much you are actually spending.
3. When estimating the cost of subscriptions or installments, always calculate the total amount for the year or for the entire period.
Conclusion
Financial traps await even smart and educated people. The illusion of money makes us forget about the real value of money.
Hyperbolic devaluation encourages thoughtless spending for the sake of immediate pleasure. The denomination effect leads to the fact that we treat small expenses frivolously.
But, being aware of these psychological characteristics, we can learn to overcome them. Budgeting, planning expenses, and the ability to think long-term - all this will help you avoid financial mistakes and improve your financial situation.
Remember: financial literacy is a skill that can and should be developed. Constantly learn, analyze your decisions, and over time you will learn to make more balanced and reasonable financial decisions.
Earlier I talked about how to increase the financial return of a business.
