You know you need to spend less than you earn, budget, pay down your student loans, and save money for the future — but you still overspend and take on more debt.
So, why do you practice bad money habits even when you know better?
This is where the psychology of money comes in. Learning about your own financial psychology can help you develop better habits that will help you become successful.
Watch out for these bad money habits and take the first step to eliminating them — so you can save money and pay off your loans more quickly.
1. Temporal discounting
Why is saving and investing for the future so hard? The answer could lie in our language.
Economist Keith Chen suggested that people who speak languages, like English, are less likely to do things that benefit their future selves. This is because language like this distinguishes between past, present, and future tenses.
People who speak a language that does not have those tenses, however, are much better at taking action. These languages, like Chinese, are called “futureless languages.”
This means that English speakers are more prone to a cognitive bias called temporal discounting. This is the tendency to mentally place greater value on a reward that exists closer to us in time than rewards that are farther away.
So when faced with a choice to either save for retirement — that exists in the future — or spend money on a trip to the beach in three months, the beach trip seems more valuable. After all, it’s happening sooner.
To avoid falling into this trap, don’t give yourself the choice. Set up an automatic transfer from your checking account to your savings account each month. You can also ensure your student loan payments are automated, so you don’t miss a beat.
2. Recency bias
Recency bias is the mental habit that causes you to remember recent events more clearly than you remember past events. You then make decisions based on the most recent event — instead of looking at the bigger picture.
This can lead you to believe that things always will be the way they are now. Thinking this way can have a disastrous effect on your finances, though — just as it did during the mid-2000s housing bubble and subsequent crash.
Many people believed that because the housing market was hot at the time, it would inevitably continue to be hot in the future. This happens the other way around, too. Average investors tend to panic when the stock market starts crashing, and they sell their holdings.
If you’re not influenced by recency bias, you can think clearly and you know the stock market fluctuates. It’s much more logical to view a dip in the market as a discount on stocks that you can buy cheaper now and hold over time until they rise in value again.
Avoid recency bias by looking at bigger trends than just day to day — or even year to year. Plan for the long term and don’t base your money habits off a single event. This will allow you to overcome the psychology of money and have more money available to pay down your debt.
3. Loss aversion
It’s easy to feel more motivated to avoid loss than to achieve gain. That innate aversion to loss influences your financial psychology in several ways.
Think back to that stock market example. It’s so difficult to stay in the market when it’s tanking because you want to avoid loss. So even though it would have been better to hold course, your instinct is to sell.
Loss aversion can also keep you in bad financial situations. This is closely related to the sunk cost fallacy. This happens when you invest in something and continue putting money, time, and effort into that thing even after you realize it’s no longer a good idea.
Because you already feel so invested, you plow ahead anyway. But just because you already made it so far, doesn’t always mean you should keep going.
In this case, you need to cut off whatever you’re pouring into the situation. It’s painful and may feel illogical, but the real irrational choice is to continue on simply because you’ve already devoted time and money.
How to avoid bad money habits
The psychology of money is a complicated thing. The tendency to act emotionally and irrationally can create money habits that sabotage your success.
So what can you do about it?
- Automate when possible. Create a budget that alerts you when you’re close to overspending. Set up automatic transfers to savings, investment, and retirement accounts. Automating your finances can help reduce the conscious choices we need to make.
- Ask for help. It’s difficult to make logical financial decisions 100 percent of the time. An objective third party can help you make rational decisions when your biases and errors in logical thinking get in the way. You don’t necessarily need to pay a financial advisor either. You can check out Facebook groups, forums, and other resources that can give you objective, outside feedback.
- Challenge yourself. The best way to avoid any kind of bias around the psychology of money is to ask questions and challenge yourself. Examine the decisions you make and consider what motivates you. Ask yourself if you’re acting emotionally.
If you feel uncertain, don’t make decisions or take actions based on intuition, superstition, or emotions. Ask questions and learn more about your situation, your options, and what makes sense for your financial situation.
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 2.98% APR (with Auto Pay) to 5.79% APR (with Auto Pay). Variable rate loan rates range from 1.99% APR (with Auto Pay) to 5.64% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of July 31, 2020, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 7/31/2020. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at [email protected], or call 888-601-2801 for more information on our student loan refinance product.
© 2020 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
All credit products are subject to credit approval.
Laurel Road began originating student loans in 2013 and has since helped thousands of professionals with undergraduate and postgraduate degrees consolidate and refinance more than $4 billion in federal and private school loans. Laurel Road also offers a suite of online graduate school loan products and personal loans that help simplify lending through customized technology and personalized service. In April 2019, Laurel Road was acquired by KeyBank, one of the nation’s largest bank-based financial services companies. Laurel Road is a brand of KeyBank National Association offering online lending products in all 50 U.S. states, Washington, D.C., and Puerto Rico. All loans are provided by KeyBank National Association, a nationally chartered bank. Member FDIC. For more information, visit www.laurelroad.com.
As used throughout these Terms & Conditions, the term “Lender” refers to KeyBank National Association and its affiliates, agents, guaranty insurers, investors, assigns, and successors in interest.
Assumptions: Repayment examples above assume a loan amount of $10,000 with repayment beginning immediately following disbursement. Repayment examples do not include the 0.25% AutoPay Discount.
Annual Percentage Rate (“APR”): This term represents the actual cost of financing to the borrower over the life of the loan expressed as a yearly rate.
Interest Rate: A simple annual rate that is applied to an unpaid balance.
Variable Rates: The current index for variable rate loans is derived from the one-month London Interbank Offered Rate (“LIBOR”) and changes in the LIBOR index may cause your monthly payment to increase. Borrowers who take out a term of 5, 7, or 10 years will have a maximum interest rate of 9%, those who take out a 15 or 20-year variable loan will have a maximum interest rate of 10%.
KEYBANK NATIONAL ASSOCIATION RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE.
This information is current as of September 9, 2020. Information and rates are subject to change without notice.
3 Important Disclosures for SoFi.
4 Important Disclosures for Splash Financial.
Splash Financial Disclosures
Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet applicable underwriting requirements. Not all borrowers receive the lowest rate. Lowest rates are reserved for the highest qualified borrowers. If approved, your actual rate will be within a range of rates and will depend on a variety of factors, including term of loan, a responsible financial history, income and other factors. Refinancing or consolidating private and federal student loans may not be the right decision for everyone. Federal loans carry special benefits not available for loans made through Splash Financial, for example, public service loan forgiveness and economic hardship programs, fee waivers and rebates on the principal, which may not be accessible to you after you refinance. The rates displayed may include a 0.25% autopay discount.
The information you provide to us is an inquiry to determine whether we or our lenders can make a loan offer that meets your needs. If we or any of our lending partners has an available loan offer for you, you will be invited to submit a loan application to the lender for its review. We do not guarantee that you will receive any loan offers or that your loan application will be approved. Offers are subject to credit approval and are available only to U.S. citizens or permanent residents who meet applicable underwriting requirements. Not all borrowers will receive the lowest rates, which are available to the most qualified borrowers. Participating lenders, rates and terms are subject to change at any time without notice.
To check the rates and terms you qualify for, Splash Financial conducts a soft credit pull that will not affect your credit score. However, if you choose a product and continue your application, the lender will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and may affect your credit.
Splash Financial and our lending partners reserve the right to modify or discontinue products and benefits at any time without notice. To qualify, a borrower must be a U.S. citizen and meet our lending partner’s underwriting requirements. Lowest rates are reserved for the highest qualified borrowers. This information is current as of September 10, 2020.
5 Important Disclosures for CommonBond.
Offered terms are subject to change and state law restriction. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900), NMLS Consumer Access. If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 0.16% effective August 10, 2020.