You are a self-sabotaging, irrational but often altruistic toad – however I say that with love in my heart. It’s not just me who thinks so; turns out there is a whole science devoted to the “how and why” we make the choices we do. Guess what they discovered – we are all hopelessly irrational.
Behavioral Economics is a rather young science that merges economics with psychology in order to study how real people make choices. When making decisions, we would think people choose the option that maximizes profits and benefits to themselves, right?
Let’s think about it. Are the decisions you make about your money, your health or your future rational?
Have you quit smoking or paid off your debt? Do you exercise and eat right? Are you saving enough for retirement? In short, are you doing the things that you know will lead to your goals?
Smart people behave irrationally (so do dumb people). It is a scientifically proven fact that we knowingly make decisions in direct conflict with what we want to happen. In addition to choosing poorly, we often sabotage our futures by refusing to choose.
David Laibson, Professor of Economics at Harvard writes; “There’s a fundamental tension, in humans and other animals, between seizing available rewards in the present, and being patient for rewards in the future,” he says. “It’s radically important. People very robustly want instant gratification right now, and want to be patient in the future. If you ask people, ‘Which do you want right now, fruit or chocolate?’ they say, ‘Chocolate!’ But if you ask, ‘Which one a week from now?’ they will say, ‘Fruit.’ Now we want chocolate, cigarettes, and a trashy movie. In the future, we want to eat fruit, to quit smoking, and to watch Bergman films.”
I know Laibson is talking about me. I definitely want to eat better and exercise more – later.
When it comes to our money, we buy stuff on credit even though using credit reduces the amount of stuff we can buy. We walk away from free money in the form of our employer’s match on our 401k and we fail to make a budget or set aside an emergency fund even though we readily agree that these are all things we want to do.
How do we overcome our irrational desires?
Recognizing that the biggest danger to my financial future is my own irrational decision-making, I have set in place a system of pre-commitments that force me to follow through my rational plan.
Here are things I do that will work for you:
- Make a budget in ADVANCE of the month and sign off on it with your spouse or accountability partner. Hold each other to the commitment.
- Don’t give yourself easy access to money or credit. Cut up the credit cards or at least hide them. Make your savings harder – not easier to get to.
- Make savings automatic – have your savings direct deposited or at least moved automatically as soon as it hits your account.
- Post the Wish List on the fridge – don’t buy things that aren’t on the list even if you have the money.
Want to learn more about Behavior Economics?
Dan Ariely, Professor of Behavioral Economics at Duke has a podcast at ITunes U called Arming the Donkeys. The segments are really short, interesting and easy to understand. Give it a listen.