Problems associated with money do not depend on its amount. Even a person who has high salary can face with financial problems. According to Sports Illustrated, 78% of former NFL players went bankrupt or experienced stress due to financial problems after first two years of retirement. Earning or winning large amount of money is also not a solution to financial issues. 70% of lottery winners go bankrupt within seven years. The main reason of their failure is not related to financial education of that people, but related to the decisions taken by them.
Why do we make bad decisions?
1. “Fast thinking“, which works automatically, largely on a subconscious level and requires a little effort.
2. “Slow thinking“, which is responsible for conscious deep analysis and requires concentration.
Jonathan Haidt, American social psychologist, have created a metaphor that allows you to better understand these principles. System 1 and 2 are elephant and rider. Elephant — system 1: big, instinctive, emotional. System 2 is the rider that controls the elephant. It is not easy for him, because the elephant is too big.
How does this metaphor relate to financial decisions?
Let’s say you have a choice: to spend the reward on vacation now or to save it for retirement to go on a well-deserved vacation after 30 years. In this case, the elephant in your head tends to instant benefits, that is, inclines you to spend on vacation. At the same time, the rider tries to make a more reasonable decision. According to a range of surveys, an elephant wins more often than a rider in this struggle.
Improving financial literacy is not enough to succeed.
A fight against natural financial beliefs in order to make profitable decisions is not an easy task. This action requires energy and can lead to financial stress.
That is why, the efficiency of financial literacy programs may not be enough to make correct decisions. According to a meta-analysis 201 regarding financial literacy conducted in 2014, such an initiative has changed financial behavior by only 0.1%. Financial specialists consider it as an insignificant result. The weakest results were observed in low-income samples.
However, it does not mean that financial literacy is useless. After all, it is impossible to solve financial issues if you do not understand the underlying mechanics. But it doesn’t change people’s behavior. Change occurs only when a person is motivated by something or fears the consequences. This means that in order to change financial behavior, you need to motivate the “elephant” more so that the rider does not have to do it.
What do you need to change to make better decisions?
Access to financial products and resources plays an important role. For example, you may be more motivated to save if your individual contributions to the corporate pension program will increase via employer too.
The sad truth is that low-income consumers do not have the same access to affordable financial products as the wealthier groups (say, many Bank cards are free only when the minimum balance is maintained).
Despite this fact, there are things that can be controlled at any income and that over time help develop the habit of making economically viable decisions.
It is important to understand the practical aspects.
Many programs dedicated to finance literacy provide guidance on what to do, but do not say how. For example, you know that compound interest over time allows you to increase wealth. But how to make regular savings a habit?
For practical advice, you can refer to books, social networks, profile sites or consult a financial advisor.
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