Why We Do Dumb Things With Money

“How could I be so stupid?”  Maybe you’re looking at a bulging credit card bill after over-spending during the holidays, just hoping your tax refund is enough to pay it off.  Or maybe you’re looking at a budget that simply won’t balance—for the 77th consecutive month—wondering how you made it this far in life without being able to master the simple math of addition and subtraction. 

Why is it that informed, educated and even brilliant people can be so dense when it comes to basic matters of personal finance?

I’m reading a book called The Checklist Manifesto by Atul Gawande, based on his fascinating article, “The Checklist,” in the December 2007 edition of The New Yorker.  On his way to making a compelling case for the use of checklists to ensure accuracy in even the most multifaceted procedures—like emergency room surgery or skyscraper construction—he gives us some insight into why we’re capable of doing dumb things in seemingly simpler processes.  In his words:

Two professors who study the science of complexity—Brenda Zimmerman of York University and Sholom Glouberman of the University of Toronto—have proposed a distinction among three different kinds of problems in the world: the simple, the complicated, and the complex.

Zimmerman and Glouberman give us a tangible example of each type of problem.  Simple is to baking a cake from a mix as complicated is to sending a rocket to the moon.  The latter requires “…multiple people, often multiple teams, and specialized expertise.”  But once you’ve marshaled the necessary manpower and know-how to send a rocket to the moon, the exercise can be successfully repeated.

This is not the case in complex problems, however.  The example they give for a complex problem is raising a child.  “Expertise is valuable but most certainly not sufficient.  Indeed, the next child may require an entirely different approach from the previous one.”  As a parent of two, this news was both heartening and frightening.  But it also helped me realize something groundbreaking, at least to me:

While many matters of personal finance seem so simple on their face, they’re actually quite complex…because WE’RE complex.

Even as a single person with no dependents or pets, our innate proclivity for self-deception is remarkable.  But within the context of a couple or family, it’s easy to see how the “simple” discipline of cash flow management, for example, can become quite complex.

Further complicating the problem is that most areas of personal finance require perpetual decision making, in which each individual decision to save, spend, buy, sell, re-allocate, contribute, distribute, insure, reduce coverage, file, expense, deduct, bequeath, endow, receive or disinherit is its own fertile ground for success or failure that could compound positively or negatively to impact the whole!

So let’s all enjoy a collective “WHEW!” as we momentarily enjoy the fact that making mistakes with money doesn’t mean we’re a complete nincompoop.  Of course, this is an explanation, not an excuse.  We’re still responsible.  Here are three ways we can all keep our financial decision making as smart as we are:

1)     Be cognizant of things financial.  Be present and deliberate when dealing with your money.  Keep these topics at front of mind by reading a good financial blog or two (ha, ha).  And consider reading my friend and colleague, Carl Richards’, new book, The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money.  (It’s the only financial book I know of that is strewn with pictures!)

2)     Develop good habits.  We often need to force ourselves to be cognizant because personal finance either bores us or is loaded with self-deception.  The development of good habits, beginning first-and-foremost with a functional cash flow system, will help us develop the behavior we’d prefer.

3)     Be accountable to someone or something.  Some are willing and able to develop their own system to maintain accountability, but for many, a healthy relationship with a professional financial planner is the key.  In my Forbes post this week, “Hey Financial Planners, Do Your Job!” I gave advisors a gentle nudge, encouraging them (us) to make financial planning a simpler, more client friendly process that eliminates complexity instead of creating it.

What are some other ways you’ve been able to keep from making dumb financial decisions in your life?

A Burdensome Yoke…Or A Path To Peace?

Well, it wouldn’t be the New Year if we weren’t reminded that one of the top resolutions that will be made and inevitably abandoned is financial in nature.  “Improve financial condition” is once again the number two resolution for 2012 in the annual Franklin Covey New Year’s Resolutions study, and the only surprise is that it’s not number one!

But no matter what year I’m asked the question, “What’s the most important thing I could do to improve my personal finances?” the answer is never going to be about tactical asset allocation, navigating the alternative minimum tax or conducting a Roth IRA conversion.  Regardless of your income, your net worth, your age or employment status, the clearest determinant of a successful financial plan for ALL of us is the implementation of an effective cash flow mechanism, or its less sexy if not diminutive synonym—the budget.

So in my first Forbes post of 2012, I shared the shocking story with which you may already be familiar, about my affluent friend who found himself on a path to spending over $1 million at Starbucks, to rebut the common misconception that rich people don’t have to budget.  But here I’d like to address the more honest, unspoken question that I believe leaves most people among the ranks of the NON-budgeters:

ISN’T BUDGETTING JUST AN ANNOYING, BURDENSOME YOKE?  ANOTHER TO-DO WITH LITTLE MORE TO OFFER THAN A REMINDER THAT I’M FALLING SHORT?

The short answer: NO.

The less short answer: MAYBE.

Budgeting may indeed be little more than a burdensome yoke destined to be cast off if you don’t dedicate yourself to it wholly.  For example, if all you ever do is track your spending after the fact, which can be quite depressing.  (“Yup, I spent more than I should’ve…again.”)  Many mistake a monthly review of spending with a glance at the bank and credit card statements for budgeting, but a spending review is barely the beginning of a genuine cash flow system.  The process is really about setting forth a desired level of spending for the future and tracking spending at frequent enough intervals that your course can be reasonably adjusted.  A half-hearted effort at budgeting is likely to net you even less-than-half the benefits.

Although I recommend you find the rhythm that works best for you, my preference is a monthly budget that is reviewed weekly.  Each of my budget categories—food, housing, charity, entertainment, and many more—are given a monthly allotment and then we (yes, if your household is a we, it’s almost impossible to make budgeting work solely as an I) review spending weekly and make course adjustments for the month’s remainder.  If you’re able to maintain a weekly rhythm of review, the process is relatively painless in the short run and you’ll save yourself more heartache (heartache is not an overstatement for many people) than you could imagine in the long run.[i]

But what really takes budgeting from routine to revelation isn’t merely mastering the mundane, but planning for the unexpected…with margin.  With the exception of bills that are identical every period, each variable budgeting category should have a built in buffer designed to weather slight variance.  Then you should also have a separate miscellaneous buffer category for emergencies, auto repairs and other occasions that fall outside the bounds of your expectations.

You’ll fall head over heels in love with the boring process of budgeting when the unexpected becomes inevitable, but you’re prepared in advance.  No wondering where the money’s going to come from.  No turning to debt.  No personal financial crisis.  Just peace.

Speaking of love and budgets, stay tuned for an upcoming post on How Budgeting Saved (And Continues To Save) My Marriage.

Wishing you personal and financial peace in 2012!


[i] The not-so-secret to any habit I’ve ever maintained successfully is that it has to be in some way enjoyable, so every Saturday I take a cup of green tea upstairs with the wooden box dedicated as the receptacle for our household receipts to my office, choose some good music to suit my mood and run the numbers.  WHAT WORKS WELL FOR YOU?

Belts and Budgets

1269613009money-belt Ahh, the holidays.  That time of year when spirits are lifted and offenses are forgiven.  When the smell of wassail and a freshly cut Fraser fir wafts through the home.  And, of course, it’s a time when both belts and budgets are stretched, almost as if it’s tradition.  I try never to ask of you something that I’ve not struggled with and asked of myself.  So it is with humility that I offer this prescription for a merrier Christmas and happier New Year regarding belts and budgets:

Eat and spend less.

Deep, huh?  Actually, it is.  Most of the mechanics of successful money and life management are embarrassingly simple; it is WE—you and me—who are hard to manage.  This stuff may be simple, but it’s certainly not easy.

The first question we should ask is, “Am I a natural?”  Do I have an innate proclivity for success in the realms of food and financial-based consumption?  Some people are blessed with a body that can incur a high-caloric blitzkrieg and not seem worse for doing so, but that’s a tiny minority.  For the rest of us, we must reach a mathematical equilibrium in which we’re expending a proportionate amount of the calories we take in.  Then, each of us has a physiological disposition that either makes it harder or easier to reach a comfortable and healthy balance.  That last component is what makes dieting a challenge—many of the variables are unseen.

Budgeting has a similar set of variables.  Money comes in and money goes out.  The primary objective is to spend less than you take in, and the “physiological disposition” equivalent in personal finance is the amount, frequency and variability in the level of income.  It is, necessarily, easier for a family with one monthly paycheck and a set of monthly bills to manage household cash flow than it is for a two-income family with self-employed individuals responsible for the income.  But regardless of the level of complexity, believe me when I tell you that there are natural budgeters—those who have a tendency to spend less than they take in—and those with a predisposition for over-consumption.  Hopefully you’re one.  (Frankly, I’m not.  It’s work.)

The first step towards managing each of these topics well, especially around the holidays when the challenge is exacerbated, is to know where we are weakest.  For food consumption, behold the “French Fry Rule”:  Know the extent of your will power.  For me, I’ve learned that I AM capable of saying NO when the server asks me, “Would you like French fries with that?”  But once the fries are on my plate, I will, invariably, eat them!  Know where (and also when) your will power is strong and weak, and play to your strengths.

When it comes to financial overindulgence, consider “The Four Forms of Money Rule”:  There are four primary forms of money—cash, checks, debit cards and credit cards—and each of us is most responsible with one and least responsible with one.  Personally, I am least responsible with cash.  If cash is in my pocket, much like if French Fries are on my plate, I’m going to dispose of it!

The key to success in both healthy budgeting and eating is to KNOW YOURSELF.  Don’t allow yourself to deceive…yourself.  Be honest and give yourself a fighting chance by playing to your strengths and avoiding your weaknesses.  And when you start to hear that lie in your head, pouting that you’re depriving yourself of a well-deserved treat, remind “it” that the balance and comfort you’ll feel when the temptation has passed is a far more desirable than the momentary indulgence.  As my good friend, Pat Goodman, tells me, “You must not only want what you want; you must want what your wants lead to!”

And if you think I’m asking too much of you, check out Leo Babauta’s blog post entitled, “The Case Against Buying Christmas Presents.”  I’m not necessarily suggesting you go that far, but Leo shares some great wisdom in here that speaks to the underlying causes of holiday-specific excess in spending and takes it to another level.