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Bad with money? Blame your brain

Part 1 of a 3 part series on personal finance management

We all know the story. It’s barely halfway through the month and our bank account is already spiraling rapidly towards zero. We blame ourselves, we tell ourselves we will do better next month, but next month arrives and it’s the same old story.

That this happens to us is no surprise. Our brains evolved during a time when little counting was needed and when calculating compound interest was still millennia away. Behavioral economists have been researching the way our mind misjudges financial challenges, and found that the ways we do this are predictable, to a large extent. Not only our flaws are predictable; also the art and science of effective personal finance management is a domain well understood. What’s currently missing are widely available tools that help us bridge the gap between what we want and what we do.

Every euro you spend is a vote for the life you value.

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Why we’re bad with money

A big challenge for managing money is to assess how much we should pay for something. How can you know how much something is worth? Economists call this assessment valuing optionality. We ought to compare all the possible ways to spend our next euro and pick the one that brings us the most value. However, due to the infinite possibilities, this exercise feels futile for most of us. The three most common challenges to managing value are:

🥰 Value is determined experientially

Those familiar with experience design already know that there’s more to value than production cost plus margin. What something is worth depends on how we feel about it. The price of a bottle of wine can vary wildly depending on the perceived effort it took to create the wine, the story that it comes with, the rituals by which its consumption is surrounded, and even how much we are looking forward to the occasion [1].

⛹🏽‍♀️ Value is determined in relationship to other things

Why do we think 7 euros for a bottle of wine, 90 for a pair of shoes, and 60 for a nice dinner is reasonable? How much something is worth to us, independent from all the other things in the world, is yet another impossible exercise. To make it easy on ourselves we compare shoes to other shoes and to our own past purchase decisions. For example, if we usually pay 90 euro for a pair of shoes, then 50 will feel cheap and 200 will feel expensive. In other words, we set the bar based on our best and most comfortable previous experiences [2]. It gets even harder when we start to compare our potential purchase to non-products. A pair of shoes vs. 4 hours of extra holidays vs. leaving work early for a week vs. retiring 2 days early. What’s the best thing to do?

🧮 We pretend we can do bookkeeping in our heads

Have you ever experienced the situation where you told yourself that this week you would take it easy and not spend extra money during lunch, only to abandon your plan on Monday when two colleagues ask you to join them? This doesn’t count as lunch, you tell yourself. This one actually comes from my social budget, and I deserve a little fun [3].

These challenges highlight how hard it is to assign a monetary value to experiences, and to keep track of them. It’s therefore no surprise that we keep on wondering if we should have spent our money the way we did.

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Loss hurts

Behavioral economics research shows that we overvalue what we have (endowment effect) in comparison to the same thing that doesn’t belong to us. We are twice as worried about losing something than gaining the same amount (loss aversion). This plays out in our financial lives in various ways.

💳 We embrace technology that hides the pain of paying

The pain of paying is the pain we feel when we realize that we can never spend the same euro again. The pain is caused by our focus on loss. The more attention we pay on paying, and the closer that payment is to the actual consumption of the good, the more it hurts. However, our desire for instant gratification makes us search for a way out. With inventions like touchless payment (no attention needed in order to make a transaction) and credit cards (again no attention needed right now), the financial industry has found ways to help us deal with the pain [4].

📊 We make bad investment decisions (or none at all)

If we were reasonable people we would use the duration of our savings as a key driver for our risk assessment. If it takes more than five years before we need it we’d be wise to invest some of our money instead of keeping it in a low interest-bearing savings account. However, our fear of loss causes us to miss out on the potential gains of investing, and instead gives us the guaranteed loss that is caused by inflation.

Even when we convince ourselves that investing is the right thing to do, we’re still likely to sell when the markets fall — and buy when everyone around us cheers. One bank that ranked their clients from most to least successful investors found that those who forgot they had investments outperformed everyone else [5].

👴🏼 If it were up to us, we wouldn’t save for retirement

In many European countries, saving for retirement is regulated and automated. Although some people wish for more freedom to build their own pension pots so they can benefit from lower costs, more transparency and better results, very few people take the initiative to make their own decisions. There are several reasons why people fail to set up their own pensions: paying feels like you’re handing money to a stranger when you could spend it now. The thought of your investments going up and down triggers loss aversion. Even when your employer is willing to match your contributions, most won’t count missing out on these matches as a loss [6].

When loss aversion helps us to make better decisions we use technology to ignore it, and when it would be a good idea to ignore loss aversion and to take care of our future, we let it speak too loudly.

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It‘s hard to decide what something is worth to us in the future

Money allows us to exchange our current labor for future goods and services. This is one of the most powerful tools that we have to help us establish a degree of certainty over an unpredictable future. If we were smart, we’d use this power and extend the ability to control the future as far as our budget allows. Unfortunately, our mind trips us up here, too.

🔭 The further away the event, the more abstract our imagination

If you invite me for a drink tomorrow I can imagine an almost filmic representation of how it will be, but if you invite me for the same drink 30 years from now nothing pops into my mind [7].

🔮 We can’t feel the future

Our recent past and the here-and-now are both filled with strong emotions. We want things, right here, right now. When we do think about the future we imagine that our future selves are are going to sort everything out (or we assume that the future is so bad that caring now is a waste of time and effort). The money needed for retirement feels like an abstract number and not very relevant to being alive now. In what psychologists call delayed reward discounting, 100 dollars now is worth 3x as much to us as 100 euro one year from now [8]. Even those among us with the lowest impulsivity will have a hard time saving for the future unaided.


Our minds developed to make fast decisions. This allowed us to survive and thrive for thousands of years. But with technologies around us rapidly changing, sometimes our quick emotional decision-making abilities start to work against us. It’s hard for us to assign monetary value to objects. We’re afraid to lose what we have, even if the gains could be bigger. Long life expectancies are only a recent phenomenon, and we have no idea how to think about time periods that reach further than a few years. But there’s hope. After all, humans are tool makers. Once the problems are well understood we can get to work and start fixing them.

In the next installment, we take a look at how to address some of the complex psychological issues around money that humans get hung up on. Once we figure out how our personal values can align with our finances, what are the practical steps we can take to put this partnership in motion?…

1, 2, 3, 4, 5: Dan Ariely, Jeff Kreisler, Small Change: Money Mishaps and How to Avoid Them
6, 8: Richard H. Thaler, Misbehaving: The Making of Behavioral Economics
7: Yaacov Trope, Nira Liberman, Temporal Construal

Written by

Senior UX designer. Interested in the space between words and things.

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