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FOOL'S EYE VIEW
By
We all have bad money habits that cost us dear in the long run. One of the best books I've read on this subject is the snappily titled " Why Smart People Make Big Money Mistakes and How To Correct Them". It's an American book, as so many of these books are, but it translates well. You'll almost certainly feel a little sheepish on more than one occasion as your own personal bad habits are exposed in all their gory detail. Ways to correct them are laid out although, of course, it's up to you to actually change your ways. Here are some highlights. Mental Accounting The human brain is a wonderful thing, but the way it looks at problems can cause difficulties. Mental accounting is one such foible, the practice of treating your pounds differently depending from whence they came. The example at the start of the book relates this perfectly. It tells of a newlywed in Las Vegas who had spent all the money they had allotted for the week on gambling. He then found a $5 chip and snuck out in the middle of the night to make a single number bet on the roulette table. He won and then won several more times, each time betting his accumulated winning on the same number. Eventually his luck ran out, and he lost many millions of dollars on the last roll. On returning to his room his wife asked where he'd been. Explaining that he'd been playing roulette, his wife asked how he did. "Not bad" came the reply "I just lost $5". Does the same thing happen when you receive unexpected money such as a lottery win, a present or an inheritance? Do you treat it the same or do you think of it as free money and spend it straight away? Another example is seeking the best price on goods that you buy. Many people will dismiss small purchases and won't bother to try and get a decent price for them. But they'll put a lot of effort into saving money on big-ticket items. Over the long term though, you'll buy a lot more of these smaller items. In total, missing out on the potential small savings that you routinely ignore could end up costing you a lot more in the long run. What about the dreaded 'Sale'? How often have you bought something just because it seemed cheap and had, say, 25% off? It's not something you really need and you wouldn't have bought it otherwise, but you'll justify it by saying "I saved £25". The truth is, of course, that you've spent £75. Loss Aversion And Sunk Costs
No one likes losses. In fact it's reckoned we're twice as sensitive to losing of a given amount of money as we are to gaining it. We don't like accepting that we're wrong, so we'll grimly hang on to things that we shouldn't and cash in those that we should continue to hold. Part of this relates to sunk costs. Once you've paid for something, you'll probably allow the amount of money you've parted with to affect future decisions. Say you lost a ticket to a show. Would you buy another? Would it change your decision if you'd paid £100 for the ticket in the first place or were given it for free? It shouldn't. Whether it cost £100 or £0, the ticket's gone now. All that matters is how much you want to see the show and how much it will cost you to replace the ticket. Regret is also a powerful force. If we make a decision and it turns out badly we'll have to suffer the pain of regret. So we try to avoid this by ignoring decisions and sitting on our hands. But deciding to do nothing is still a decision and it can be as regrettable as any other. It can be hard to change these types of habit, because they come from the way we're wired, but with a little effort we can all learn to stand back and look at things in a more prosperous way.