How to Stop Making Foolish Money Decisions

Three common mistakes to avoid

You don’t play games without knowing the rules first. With money, it’s no different. You have to learn the rules first.

If it’s your hard earned money or a gift card, it’s still money. Spend it wisely.

According to Dan Ariely and Jeff Kreisler, authors of Dollars and Sense: How We Misthink Money and How to Spend Smarter, “We’ve seen how we think about money incorrectly, how we assess value in ways that have little to do with actual value, and how these get us to misthink and misspend our money.”

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Once you change your mindset, spot your spending triggers and budget busters, you can stop them and get your finances back on track.

HOW TO STOP MAKING BAD CHOICES ABOUT MONEY

As an adult, you have confronted many problems managing your finances. With these simple but essential financial tips, you’ll tame your spending habits to make them work for you.

Also, it’s important to teach these basic finance tips to your kids and save them from the struggle later in life.

Dan Ariely and Jeff Kreisler explain why we make foolish money decisions through these common mistakes to avoid. In the end, you’ll spend your money wisely, and improve your financial situation.

Stop Making Foolish Money Decisions - three common mistakes to avoid - Dollars and Sense

1.- We ignore opportunity costs

Opportunity costs are present anytime we buy something, even if we are unaware.

“Opportunity costs are alternatives. They are the things that we give away, now or later, in order to do something.”

Mostly, we think about opportunity costs before we make important purchases, for example, buying a house. However, the problem lays in the choices we make every day.

We don’t realize what we give up when we buy something, sometimes we don’t even need. “For instance, we can translate dollars into time—how many hours of wage, or months of salary, we must work to pay for something.”

We could add to our savings to buy the house if we give up buying things that we don’t need, just because they are on sale and we don’t want to miss out on a bargain.

Be Smart About Your Money - Spend Your Money Wisely - Dollars and Sense

2.- We forget that everything is relative

We need a context to measure the value of goods and services. But, in our attempt to make the right choices, we compare items, and that creates a relative value.

However, if we don’t consider the opportunity costs—only compare the item to one or two alternatives—the relative value works against us.

Don’t use sale signs to provide context

To consider buying something with a special offer or discount, we shouldn’t take into account the regular price, or how much we’re saving.

We should consider what we spend. For example, if you bought a $100 shirt at 40% off, you didn’t save $40, instead, you spent $60.

Right: Compare $60 to $0, or the alternatives-opportunity costs- items you could buy for $60.

Wrong: Compare $60 to $100, and think you saved $40.

Try not to think in percentages

“When relativity comes into play, we can find ourselves making quick decisions about large purchases and slow decisions about small ones, all because we think about the percentage of total spending, not the actual amount.”

For example, at a car dealership, a customer bought a car for $25,000, and an add-on (a CD changer) for $200.

The customer accepted because the 0.8 percent of the total purchase price seemed no big deal.

On the other hand, the same customer who didn’t give a second thought to $200 on an additional purchase on a $25,000 car “might use a discount voucher to save 25 cents on a bag of crisps or debate about a dollar or two tips at a restaurant.”

3.- We compartmentalize

Mental accounting, a tool used for budgeting, is “another way we think about the money that has little to do with actual value. Mental accounting can be a useful tool, but it often leads to poor decision-making, especially when we’re unaware we are even using it at all.”

The problem: We categorize our money the wrong way. We divide our money into different mental accounts, with different rules, depending on:

How we get it.
How we spend it.
How it makes us feel.

For example: if we receive a gift card, probably, it goes to our entertainment mental account. With the gift card, we buy things that otherwise we’ll never buy with our hard-earned money.

In the end, it doesn’t matter where the money comes from “If we find ourselves splurging with certain “kinds” of money—just because in our mind the money belongs to the “bonuses” or “winnings” account—we need to pause, think, and remind ourselves that it’s just money. Our money.”

Dan Ariely and Jeff Kreisler conclude that “relativity and our inclination to make the easy choice leave us susceptible to multiple types of external interventions and manipulations by those who set the prices, including decoys.”

It’s our responsibility to take charge of our finances. It’s essential to educate ourselves to avoid mistakes and make choices now that we won’t regret later.

Authors Dan Ariely and Jeff Kreisler
Dollars and Sense: How We Misthink Money and How to Spend Smarter Published by Harper (November 7, 2017)
ISBN: 978-0062651204

ARC by Edelweiss