Jan 9, 2009

Hidden Flaws of Spending - Why Do We Make Fatal Money Mistakes

Beware the fallacies into which undisciplined thinkers most easily fall – they are the real distorting prisms of human nature

-–Francis Bacon

Why do we find it hard to save? Economy theory explicitly assumes that people are rational decision makers - people make best possible economic choices, delay gratification in pursuit of a greater reward tomorrow, want to maximize returns, eliminate unnecessary expenditures, and save for future.

In reality, we are all emotional humans and not completely rational. Richard Thaler in his book Winner’s Curse says “…we are neither pure saints nor sinners-just human beings…”

We regularly assume that we know more than we actually do about money and routinely and repeatedly make bad decisions over money. We know how much we earn, but have no idea how much money we spend. How can we possibly manage our money, if we have no idea where it goes?

To spend less than what we make, we need to understand how much we spend, where we spend, and why we spend the way we do. No one is here to judge whether the motives behind our spending are right or wrong. However, knowing why we spend the way we do gives us a better idea, if that spending is the answer to what we really seek. The idea is not to give up everything and become a monk.

It is said that one should know the toxicity of poison before taking an antidote; thus, understanding the pitfalls inherent to our thinking is our best defense against bad spending behaviour. For treating the root cause rather than the symptoms, first we need to understand the psychology of spending (i.e., psychological factors influencing our spending).

For winning the battle of overspending, understanding the emotional factors and biases which often lead to compulsive spending habits and living beyond our means is necessary. Biases are like holes in our reasoning abilities and can impair our decision making. By developing understanding of biases that affect our buying decisions, we can avoid becoming victim to them.

Furthermore, personal finance is not just about investment and tax planning. It’s much more than that. Money management (budgeting & saving) is a vital task which is extremely important to any family’s financial future. However, after insurance, money management is the second most important but neglected area in personal finance.

Therefore, in this series of articles on money management to be published on monthly basis (starting shortly), you’ll learn the nuts and bolts of money management.

I’ll cover in detail the following topics:

1. Hidden Flaws of Spending: Individual Specific Flaws
2. Hidden Flaws of Spending: Marketing Gimmicks
3. Saving Strategy 1: How to Make Smart Buying Decisions
4. Saving Strategy 2: How to Make Lifestyle Changes
5. Saving Strategy 3: How to Become Financially Literate
6. How to do Personal Budgeting

So, STAY TUNED!

Also see:

1. Savings - A Step towards Sustainable Living

2. 10 Reasons Why You Need a Savings Plan

3. Hidden Flaws of Spending: Individual Specific Flaws (# 1)

4. Hidden Flaws of Spending; Individual Specific Flaws (# 2)

5. Hidden Flaws of Spending: Marketing Gimmicks (#1)

2 comments:

  1. Hi Fisher,

    A nice post! You are rocking!

    Cheers,
    -Vikram.

    ReplyDelete
  2. Thanks for the motivation, Vikram!

    ReplyDelete

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