When most people think about money, they think about the effort it takes to make it. They think about slaving away at their 9 to 5 job, either punching away at their keyboard or working manual labour at a construction site. There is no doubting the fact that our income can be affected by our physical efforts however money has many mental aspects as well that people often overlook. These mental aspects range from tricking us into spending more money to being able to make more money ourselves. As such, here are 5 psychological money tricks you absolutely need to know!
Trick #1: Mental Accounting
Let’s start off by identifying a situation where your mentality may be hurting your financial situation. By nature, money is fungible, which means every dollar has the same value regardless of how we get it or store it. But our brains didn’t get that memo, so we treat different types of money differently. We’re tempted to splurge with windfalls, for example, or to be more careful spending cash than using credit.
For example, when you last received money for your birthday, what did you do with that money? Did you save it? Probably not. You probably saw that money as extra cash and spent it on that new phone or gaming console you wanted. However, like we just said, money is fungible meaning that the $200 you received for your birthday is the same $200 you would receive from your employer on pay day. The only difference is the source it came from. Succumbing to poor mental accounting will have you making unadvisable financial decisions but luckily you can use this mindset to your advantage.
You can put this mental accounting to good use by creating multiple savings accounts, each labeled with your goal for the money. For example, you could create accounts called “vacation,” “car repair fund,” “home down payment” and so on. Online banks and credit unions typically make this easy by allowing you to create and name numerous subaccounts without minimum balance requirements or fees. Labeling and segregating money could help you keep your hands off of it. While you might dip into a general savings account for a questionable purchase, you may resist the urge if you can envision having less money for your vacation or not being able to pay for a needed car repair.
Trick #2: The Reciprocity Effect
You’re finishing up your meal and you begin to calculate in your head how much of a tip you should leave your waiter. You think you’ve got the number figured out but as he hands you the bill, he slides a candy on the table to thank you for being such a great guest. If you’ve ever experience this, then you’ve been the victim of the reciprocity effect.
Introduced in Dr. Robert Cialdini’s book, Influence: The Psychology of Persuasion, the concept of “reciprocity” is explained that if someone does something for you, you naturally will want to do something for them. Now, you may be thinking that there’s no way you are going to let a mint change how much you will tip at a restaurant but studies say otherwise. According to studies performed by Dr. Robert Cialdini himself, when servers bring a check to their patrons without a mint, the diners will tip according to their perceptions of the service given. With one mint, the tip jumps up 3.3%. Two mints? The tip jumps “through the roof” to roughly 20%.
But it’s not just waiters who are getting rich by using the power of reciprocity. Retailers have been known to give gifts or discount coupons to their customers which then trigger inner guilt in these shoppers to spend at least some amount of money after having been recipient of what is framed to be a kind gesture. This effect preys on our desire to be consistent with our good nature and treat people as well as they treat us which in this case makes our wallet a little bit lighter.
Now, this is how the reciprocity effect can drain your bank account but when you employ this psychological tactic, you can use it to make more money. If you run a business, this is easy. Say you run an online marketing company that improves search engine optimization for businesses. If you were to give them a free audit of their corporate webpage and identify areas they could improve on, you will have given them upfront value that will trigger their need to reciprocate.
This could be through hiring you on to do more work or at the least passing along your name to those who may need your services. From an employee perspective, this can be done by going above and beyond for your boss. Working later and filling in when needed will trigger your boss to reciprocate and compensate you handsomely when raise or bonus time comes around. Therefore, while the reciprocity effect can cost you money, it can do the opposite when you know how to use it!
Trick #3: The End Of Time Illusion
Think of the person you were a decade ago — what you thought was important, what you liked and disliked, how you behaved. If you’re like most people, you’ve changed, but you also probably think that the person you are today is pretty much who you’ll be from now on. Regardless of their age, adults consistently underestimate how much they’ll change in the future.
This illusion leads to the tattoo, mortgage or marriage you later regret. But the end-of-time illusion could be beneficial if you use it to give your future self more, rather than fewer, options.
Here’s an example: People who save for retirement often anticipate the freedom and leisure they’ll enjoy one day when they can quit work. They can’t imagine they’ll feel differently later. As they get closer to retirement, though, some realize they want to keep working at least part time for the extra money, the intellectual stimulation, the social benefits.
However, there are some situations that may even prompt your retirement years to come sooner than you think. For instance, you may suffer a health event that limits your ability to work or you receive a large windfall of money and can cut off the final few years of your career.
Finally, like I just explained, your desires in life will change over time and you may pick up a hobby that is rather expensive which will change your financial situation in your golden years. Perhaps you will catch the travel bug and will want to visit new countries or will take up a new sport.
This is all to say that with sufficient savings, you typically have more options: You could quit, work part time, work full time, take a break and return to work or start your own business. If you haven’t saved, you may have little choice but to keep working so always be aware of the End of Time Illusion.
Trick #4: Inaccurate Discounting
Our hard-wired preference for short-term payoffs, even when we would get more by waiting, is known as “Inaccurate discounting.” We know we need to save more for retirement, or pay down debt, or build an emergency fund. In the moment, though, we want to spend our money in other ways.
But inaccurate discounting can be leveraged to create good outcomes as well. Behavioral economists have designed interventions where people commit to saving a portion of future raises. The economists figured opportunities to save future income would be considered more attractive than giving up current income. They were right: Retirement plan participation and contribution rates rose at the companies that tried this approach.
Saving future income is also the idea behind automatic escalation. Many 401(k) plans allow you to sign up now to increase your contribution in the future by, say, 1 percentage point a year, and some plans have automatic escalation as the default. The IRS also offers a “save more tomorrow” plan: You can split the direct deposit of your next tax refund, sending part to your savings account and the rest to checking. It would be great if we were always rational and could count on ourselves to make smart decisions. Since we aren’t and we can’t, using these workarounds can help us get better results with our money.
Trick #5: The Scarcity Effect
You’re researching tickets for your upcoming vacation and on the screen flashes “Only 3 seats left at this price!” so you open your wallet, key in your credit card information and hope that you didn’t just make a terrible mistake.
The scarcity effect is one of the oldest psychological tricks and is certainly one of the most powerful. In 1975, a study was conducted to see how scarcity affected people’s perception and what better tool to use to do this than cookies. Researchers put 10 cookies in one jar, and two of the same cookies in another jar and asked participants to rate their taste. As it turns out, the cookies from the two-cookie jar received ratings twice as high as the 10 cookie jar even though the cookies were exactly the same.
This psychological phenomenon relies upon the economic principles of supply and demand that states that the scarcer an item is the more valuable it becomes. This effect is often seen in the housing market. As soon as the number of houses for sale becomes limited, people become willing to pay much more than market value as they perceive the remaining inventory of houses as being more valuable. This is why we jump at the chance to buy things in limited supply which often times is just a ploy to get us to think less and spend more.
Now, I’m sure we’ve all felt that sense of urgency come over us when something we desire to possess becomes scarce but knowing how this effect operates will not only save you money but can dramatically increase your income. On the spending side, when you feel that tightness in your chest as the urgency sets in, ask yourself, is this logically the last unit of this item I desire? When you remove emotions from the equation it is much easier to make a decision that is in line with your best interests.
On the income side, using the scarcity effect can be powerful. If you run a business, then using urgency shock to trigger customers to buy your products is an obvious strategy to employ however your options to use this effect aren’t as evident as an employee. Say you work in a tech company as a sales agent. Let’s say you have IT skills that are comparable to all your peers meaning that there would be no reason for your employer to pay you any more than your colleagues.
Then, let’s pretend your company suddenly gets engaged by a large French company looking to buy $25 million worth of hardware a year. You, being the only French speaker in the company, then possess a skillset that becomes uniquely valuable. Not to mention, French isn’t a language that is common in your city so replacing you would be no easy task. All of a sudden, you become a scarce resource for your business and wanting to ensure the success of this ongoing deal, your employer will now feel the need to place more value on you as an employee. This is when you gain leverage to negotiate with your employer a higher salary or bigger bonus and ultimately increase your income.
Therefore, while seeing something you want as being scarce can cost you money when you succumb to the emotions that it invokes, when you can use it to your advantage, it can be a wildly powerful.