3 Mistakes to Avoid in Personal Finance

The combination of loss aversion with mindless choosing implies that if an option is designated as the “default,” it will attract a large market share. Default options thus act as powerful nudges.”– Richard Thaler

Most of us want to avoid making financial mistakes when it comes to investing. Yet, we behave irrationally at times and commit some serious mistakes that cost us a huge financial loss. Interestingly, we don’t want to make such mistakes to begin with especially while taking some economic decisions. However, we are governed by our behavior which is different from Econs, who are perfectly rational fictional creatures and who tend to make economically wise choices. The term Econs was coined by behavioral economist Richard Thaler in his book “Nudge: Improving Decisions about Health, Wealth, and Happiness.” While it is not easy to become a financially literate robot, we can avoid making some mistakes. If you want to make wise financial choices, you must avoid making these three mistakes.

Present Bias

Most of the motivational speakers talk about living in present moment.  But, some people take this too literally and spend their entire money on making their present moment beautiful, without thinking about what the future will look like. Of course, it is good to stop worrying about your future, but it is not good to spend your entire funds on meeting your present day wants that you end up having nothing for future. In other words, one should not make such decisions that in future it is difficult to justify those actions and decisions.  Present bias is not always about instant gratification, it is making wrong decisions based on the present moment. For instance, after the financial crisis of 2008, many investors lost trust in real estate investing.  The decision to move the future investment based on your current market is what is termed as irrational by economists. So, avoid present bias as much as possible, because future is still a mystery and can be way different from your present moment.

Endowment Effect

This kind of bias or anomaly is very common in a real estate market. If the owner has a property up for sale, he or she will value it so high that buyer will not be interested, which may cause the owner to reduce the prices eventually.  The reason for such a high value in the first place is not the actual valuation of the property, but it is difficult for the seller to let go of that property. At this point, the seller is biased with the endowment effect which is also known as the status quo bias. Another example of such type of bias is when your favorite stock, which was once the darling of Wall Street, has surged and you want to hold on to that investment in the hope of avoiding losses. Well, this habit needs to change in order to get the money out of that sunken stock and be useful.

Optimism Bias

It is good to be optimistic and to think positive about life situation, but at times we tend to be over-optimistic and this tendency results into huge financial losses.  Suppose the property rates are going down, will it help to be optimistic and think positively? You got to secure your investments so that your future can be truly positive. You need to face the situation and cut your losses before it is too late.

The median person still thought that their prices were going to go up. That’s the definition of a bubble.”– Richard Thaler

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Three Tips for Smart Shopping

If you thought that you are a smart shopper because you are good at predicting the money you will spend for shopping, you will be surprised with what researchers have to say. Researchers believe that people are bad at predicting how much money they will spend or save. Johanna Peetz and Roger Buehler conducted a research in 2009 and found that people were bad at predicting how much they are going to spend next week. They tested this with a group of Canadian undergraduates were asked how much they are going to spend next week. Some of those students thought that they are prudent and will spend less and their targeted amount was less whereas when they actually went for shopping they ended up spending way higher than the targeted amount. For instance, one student said she will spend $94, whereas she actually spent $122 and this was her best estimate after knowing that a week before she had spent $126. So, what is the reason behind this wrong calculation, the reason is simple we don’t truly know ourselves and our spending habits and this is the reason why we promise and make new year’s resolutions that we will save money but we don’t know that where and why do we spend.  It may also be the case that we are overconfident about our thrifty behavior and we can’t see the leaks. Therefore, it is important to be aware of our own behavior whether it is our spending behavior or general self-awareness.  Here are some tips and tricks that will help you stick to your targeted spending.

Stressed vs. Desserts

Desserts are stressed written backwards and hence desserts are antidote to stress. When you eat some desserts or comfort food, you seem happy. I am not talking about eating comfort food here. There is a strong connection between impulse shopping and stress. When you are under stress, your brain needs to release what I call happy chemicals to bring you back on track and either deserts or impulse shopping can release those happy chemicals instantly. Therefore, never shop when you are stressed because you are going to spend more than you can because your brain is going to release those happy chemicals while you are shopping. In other words, you will be conned by your own brain, if you go shopping while in stress.

Eat before you Shop

Now, again this is related to eating, but actually we are talking smart shopping and saving money. In a research study conducted by Gilbert and Wilson (2000) it was found that hungry shoppers spend more money than the shoppers who stuffed themselves before shopping. The reason is very simple, when you are hungry you will see a pack of fancy snack which will stuff you immediately and in that you might not pay attention to the price, calories and other stuff. Again, your brain will draw your attention to the fact that you are hungry.

Leave Children at Home

Indeed, it is rewarding that you have your sweet time when you are shopping alone I mean without little ones. But, the biggest reward is savings. It is a no-brainer that kids are sometimes demanding and you add more stuff which you did not want to. Moreover, when children are around, it is difficult to spend a long time comparing products and making smart choices because you are busy taking their (children’s) hands off the items on the aisle. So, the best way is to shop when you have free time or your kids are on a play date.

Investing Made Simple with 3 Easy Steps

Many people fail to invest because they fail to set aside money for investing.  Some people feel that it is difficult to set aside extra money due to limited income. My common sense suggests that there are only two ways to find that extra money for investing. Either you need to work little extra harder to earn it or you need to cut down your spending. The first option may require some time, but the second one is achievable and that too in 3 easy steps.

Set Financial Goals

Whether you are worried about the future of your children or you want to save for your retirement, write down your goals clearly and be specific. When you write your goals, write an estimated amount of money you will need at the time of your retirement or for the education of your children. Make sure your goals are affirmative sentences. For instance, “I will have $—- by the end of year—- for (retirement fund/education fund). If you have clearly written goals that are positive, your mind will constantly remind you of your goals. As Jim Rohn said, “You want to set a goal that is big enough that in the process of achieving it you become someone worth becoming.” I have used this philosophy in reaching my financial goals and it requires a little change in thinking rather than making a paradigm shift in your mindset. Your financial strategy should be simple and in line with your lifestyle, resources and your preferences.

Control your Consumption

The main reason of wealth building and investing is to increase the purchasing power in future by putting off current consumption. In other words, by curtailing your expenses today you can have more in hand in future and that is enough to cover all your basic needs and wants that arise at that time. Now, curtailing your expenses or deferring your consumption does not amount to not spending any money on basic needs of your life. It simply means that you manage your expenses efficiently. In other words, you need to distinguish between needs and wants.  Take care of your pennies and the dollars will take care of themselves, goes the famous proverb and it is for a good reason.  By curbing the small expenses, I am sure you will find some extra cash for investing.

Get into a Financial Discipline

Many people who are successful in all walks of life attribute their success to discipline. Investing is no exception to this cardinal rule. So, by following a discipline of saving you can find extra cash for investing.  So, controlling your spending habits is not a one day affair, it is something which you need to practice every day or every week. If you are a coffee lover, skip a trip to Starbucks for least 3 days a week to see a small fortune at the end of the year. Now, I might fail to appeal to everyone’s reason, but this has worked for me and has made me a disciplined and self-regulated person, which indeed has bigger rewards. So, set your priorities and stay on course to get results.

Look at the tree in your backyard and always remember that it did not grow overnight and someone had carefully planted it a long time ago. Similarly, you need to plant your wealth tree now in order to enjoy its shade years later.

Happy Mother’s Day

On this day, I wish all the readers of this blog a very Happy Mother’s Day. Today, I remember the lessons I learnt from my mother who was my first teacher. Not only she taught me how to lead a good life, but she instilled in me the love for knowledge and education. It is because of her I am who I am. She taught me valuable lessons in personal finance, which I want to share with my readers.

  1. Apportion your income

I was born and raised in India, where we get paycheck once a month. When my father used to get his salary, at the end of the month, my mother would keep a fourth of it it as savings and a fourth  as emergency fund. She resisted her temptation to spend more. Till date, I follow this advice and save first before I spend.

2.  Drop by drop we fill the pot

my mother taught me the importance of small savings and controlling small expenses that could make a difference. Time and again, she proved how small savings over  a year translate into small fortune. I follow this advice and tell my children that ever penny counts.

I would love to hear from my readers what personal finance lessons they had learnt from their mother.

Happy Mother’s Day.

Can Money Buy Happiness?

Money has never made man happy, nor will it, there is nothing in its nature to produce happiness. The more of it one has the more one wants”—Benjamin Franklin

This is not the first time anyone has asked this question. In fact, many people wonder whether more money is equivalent to more happiness.  Lack of money is often associated with lack of happiness and in fact, it is considered as the root cause of all evils. However, it is not the case always.  Some people are able to lead a better life despite having less money.  Researchers have associated happiness with the hedonistic pleasure or life satisfaction and meaningfulness of life itself. Some people find meaning in life and they live a more fulfilled life.  There are people who have immense wealth but are not happy.  But what makes people unhappy? Here is the lowdown on the happiness and its relation with money.

Wealthy vs. Rich

Coco Chanel once said, “There are people who have money and people who are rich.” So there is a huge difference between leading a richer/fulfilling life and having money. Not spending or using your money to get different experiences or just hoarding your money, is not going to make you happy. In order to get maximum life satisfaction, one needs to experience and experiment different things. Sometimes people with small income are able to lead a happier life; a life full of joy and experiences that are worth remembering. The truth is many people do not know what makes them happy and they are involved in passionless pursuit of earning more money. Therefore, many people are wealthy but not rich. So, get your daily dose of happiness by indulging in some voluntary work or learning a new skill that gives a whole new meaning to your life.

Materialism vs. Money

Jonathan Swift once said, “A wise man should have money in his head, but not in his heart.” Indeed, it is important to have a desired level of money in order to live a comfortable life, but being greedy is like inviting more worries. Research has shown that people who have materialistic goals are not necessarily the people who are happy. In order to be happy, one needs to attain financial freedom so that they are free from the worries related to money.  But, if you want to earn money for the sake of making more money without using it for the right cause or for hedonistic pleasure, you are not going to be happy.

The truth of matter is money cannot replace the joy of walking in the woods or gazing the stars. Smell of money may be good but it cannot equate smell of roses. So, money cannot always buy happiness, but finding meaning with that money can.

Don’t let making a living prevent you from making a life”–John Wooden