People make irrational decisions—especially when it comes to their money. Researchers tell us that we will indeed pay more for the same cup of coffee when offered a different experience to go with it. You know who we’re talking about. Before Starbucks turned coffee buying into an extravaganza, paying more than a couple of dollars for coffee was crazy.
You may think we’re making this up, but we’re serious. Here are a few other irrational money behaviors people show according to Dan Ariely who explores this side of human nature in his book, Predictably Irrational: The Hidden Forces That Shape Our Decisions.
- We are willing to pay more for something when something free is involved.
- Once a price is established in our minds, we will compare other similar items to this ‘anchor’ price.
- We only forget about the ‘anchor’ price when the experience feels so different, it’s incomparable (yep, Starbucks).
- We start to feel ownership towards things before we even own them.
- Options distract us because we have an irrational compulsion to keep doors open.
And this is the tip of the iceberg when we start looking into irrational financial decisions. Though hidden forces may shape the way we think about and spend money, the good news is that we are always capable of making deliberate financial decisions.
One of the most irrational decisions people make is with investing. The truth is most people who invest in the stock market have no idea what they are doing. They just know their money is being invested. That seems irrational to us—especially when we’re probably talking about your retirement savings.
Knowing that we sometimes make irrational financial decisions is the first step to becoming aware of them. Let’s get really clear about some principles of a rational money management strategy that will benefit you for the rest of your life.
Principle 1: Get a handle on your money
If you track it you can control it. First, take a look at where your money is going. You may be surprised where you’re spending irrationally. Then start a budget. Track where your money should be going. Think of it as a scoreboard—we all play better when we’re keeping score. Find or make a tool that will help you create a financial statement. Many financial tools are available for either free or low cost. We’re thinking something like your current online bank account budget tool, mint.com, quicken, or moneymastery.com.
Your goal with this principle is to make sure you start building a reserve—if you don’t have reserves, you shouldn’t be investing. If you want to take risks with your money, that’s fine—just make sure you have a fallback plan. So, cover your expenses, build your reserves, and then start investing intelligently.
Principle 2: Create a deliberate strategy
Know what your end goal is or what winning means to you. You can define this based on your personal values. For example, “I want to be here at 50, I want to be here at 60.” Think about it, define it, and then write it down. The way you go about achieving this will be your financial strategy.
Next ask yourself how you can reverse-engineer the steps you need to get there. A short-term example may be if Steve wants to take his family on vacation next year. He would first gather data about the cost, then reverse-engineer what he will need to do to make sure the money is available to him. This way he makes calculated financial decisions.
Principle 3: Anticipate taxes
If we look at history as a guide, taxes will likely keep going up. So we can anticipate that we will be paying more taxes in the future than we are paying now. Interestingly, most people have money in financial situations that are tax-deferred. If you’re deferring anything to the future it’s a gamble with the amount you’ll actually need to surrender to the IRS. You may need to ask yourself, “How I can better position my financial strategy from a tax standpoint?”
Principle 4: Be prepared
Scouts have a point here. It’s pretty likely that because you’re human, bad stuff will happen to you at one time or another and affect you financially—it’s the nature of being alive. We strongly believe that if you are prepared you will make better decisions with your money. You’ll be able to separate the emotional reaction like anger, greed, or fear that would lead to an irrational decision.
Pro tip: When you start tracking your money and discover how much you may be wasting or leaving on the table, you may experience emotions like regret, disappointment, and frustration. Be prepared. We hope you also feel proud, optimistic, and motivated for taking steps to create a better financial future for yourself and your family.
There’s a lot of scarcity thinking out there, regardless of where you are now, look at the resources that you have and make the best decisions for you. There’s enough for everyone. There’s room for everyone at the table of financial security. When we consult with people about their financial future, we emphasize that the best way to implement all of these principles is to become more educated.
In that vein, we have a commitment to continual learning that offers you a return, so we’ve created a FREE, extensive eCourse called Perpetual Wealth 101 to help you take back control of your finances. It only takes 2 minutes to sign up and receive access to video tutorials, articles, and podcasts. It literally costs you nothing to become educated on this ideal strategy and start changing your wealth paradigm!
Take advantage of this FREE resource by clicking below.
Q: What are the four principles discussed in the article for rational financial management?
A: The four principles are gaining control over your finances, creating a deliberate financial strategy, considering future tax implications, and preparing for unexpected financial challenges. These principles provide a comprehensive approach to rational financial decision-making in a complex world.
Q: Why is gaining control over one’s finances important?
A: Gaining control over finances enables individuals to have a clear understanding of their financial situation, make informed decisions, and establish a solid foundation for effective financial management. It empowers them to align their financial goals with their current resources.
Q: How does considering future tax implications contribute to rational financial planning?
A: Anticipating future tax implications allows individuals to make tax-efficient financial decisions, potentially reducing their tax burden and optimizing their financial strategies. It ensures that financial plans are aligned with long-term tax goals.
Q: Why is preparing for unexpected financial challenges a crucial aspect of rational finances?
A: Preparing for unexpected financial challenges ensures resilience in the face of unforeseen events such as emergencies or economic downturns. It helps individuals maintain financial stability and continue pursuing their financial goals even in uncertain times.