Psychological Effects and Finance

Psychological effects and finance by Wendy IngorvaiaHumans are emotional creatures that are often drawn to ugly actions, even when we know they’re bad for us and we should be doing something else.  A large part of becoming a better person and managing your own life (as well as your finances) involves reducing this emotional behavior.  The first step to doing that is to understand your blind spots and recognize those tendencies that could be hurting you.  There are various behavioral phenomena you should be aware of to more effectively control your actions and protect yourself from those that might try and exploit you.  I recently came across an article that shares some ways you can overcome these challenges, listed below:

The Diderot effect: When you buy a new house, you often have the urge to spend money on it: more furniture, a new paint job, etc, since your old items don’t seem to measure up anymore.  This can also occur when you buy a new shirt and feel the need to buy new shoes as well to create an outfit.  This is known as the Diderot effect, where the introduction of a new possession can result in buying more.  To stop this, develop a responsible plan to pay yourself first and save for emergencies.  This will create a positive environment of “forced security” that can stop you from wasting money.

The Zeigarnik effect: The Zeigarnik effect is a psychological tendency to dwell on an uncompleted task rather than one that’s been completed.  This can be tied into your financial life  as well; there are many issues that need to be addressed, but people often fail to set up a basic financial plan, leading to a huge amount of stress that can paralyze you into inactivity.  As unpleasant as addressing these issues with loved ones can be, it will ultimately offer you more relief.  However, it does take effort to address basic financial issues proactively.
The Pareto principle: Also known as the 80/20 rule, about 20 percent of things are vital, and 80 percent are trivial.  For example, just 80 percent of a company’s revenue could be coming from just 20 percent of its customers.  This can also relate to many areas of your personal and financial life.  Think about how you apply your energy and financial resources; the typical person could set themselves up for a successful retirement if they could allocate just 20 percent of their income to saving for the future.