4 Ways Your Brain Screws Up Your Money AND Your Love Life
Believe it or not, your love life can tell you a great deal about your poor financial decisions. According to psychologist Daniel Crosby, a number of the terrible romantic decisions that we've all been guilty of also have financial counterparts. And just as you might rush headlong into a bad relationship if you don't stop to think about your decision-making process, you're likely to follow these same faulty processes into bad money choices.
Here's how your brain leads you to embrace toxic romantic partners and poor money decisions, and what you can do to save yourself from both. (See also: Relationships and Money)
The Illusion of Control
All of us feel like the hero in our own story. And as the hero, we're sure that we can bring about great change — whether that change means getting the brooding and solitary lone wolf type to commit, or ensuring that your retirement portfolio beats the market index.
Basically, all of us suffer from the illusion of control over external events. Daniel Crosby describes this as the "I Can Change Them" bias. We all have a tendency to believe that our own abilities will overcome our partner's alcoholism, commitment phobia, or nasty temper when it is impossible for anyone to fix something in another person.
When it comes to finances, this illusion of control is the reason why participants in a study were willing to spend almost four times more on a lottery ticket if they were allowed to pick the number themselves, rather than simply accept a randomly-assigned ticket. Even though the odds of winning a lottery are the same whether the number you play is randomly chosen by machine or carefully selected by you, you are more likely to feel as though you have some power over the outcome if you make the choices.
The illusion of control bias is also why we have a tendency to invest more heavily in companies we have some sort of relationship with. For instance, Daniel Crosby gives the example of Facebook's rather disappointing IPO. Even though Facebook "released a clear-eyed appraisal of their future prospects that included talk of slowing growth, decreasing margins, and a user shift to the less profitable mobile platform…we ignored them because, 'like, we totally check our Facebook feed like five times a day.'"
If life were a movie, you certainly could reform the bad boy, pick the winning lottery number, and see your favorite companies go gangbusters. But you only have control over what you do — and there's never going to be a moment when the music swells and your heartbreaker will ride up on his motorcycle with your winning lottery ticket in his hand and a proposal on his lips. You simply don't have the power to make it happen.
New Era Thinking
If, like me, you recently watched the end to the nine year run of "How I Met Your Mother" and considered hunting down Carter Bays, Craig Thomas, and Josh Radnor and slapping them each soundly across the cheek, then you understand the frustration of new era thinking.
In romantic relationships, new era thinking sounds like this: "I know I've been married six times, but this time it's different!" In terms of HIMYM's finale, it's the ridiculous notion that (spoiler alert!) Ted and Robin's relationship will actually work out this time, despite nine years of evidence to the contrary.
Investors suffer from similar delusions. According to Antti-Ville Suni and Mark Ingram, authors of "Behavioural Corporate Finance: An Introduction," getting swept up in new era thinking means being certain that the game is now changing:
More often than not, such new eras involve the dismissal of lessons learned from past economic crises with the notion that this time is different because of new sophisticated financial instruments, higher rates of saving and growth, stable exchange currency, new technology, the rise of a foreign power, or some other X-factor.
There have been two instances of large-scale economic new era thinking in the past 20 years: the dot-com bubble of the 90s and the housing bubble of the 2000s. In both cases, we were all convinced that things were different now because we believed in the 90s that the Internet was a source of limitless profit and because we believed prior to 2008 that real estate prices could only go up.
Just like the optimistic Liz Taylor heading down the aisle for the eighth time or the starry-eyed Ted Mosby once again committing minor larceny in the form of a blue French horn, we investors like to tell ourselves that this time is different!
Unfortunately, those who ignore the past are doomed to repeat it, as they say.
The Prince Charming Bias
Pretty much every fairy tale ends the same way: Prince Charming swoops in and solves all of Princess What's-Her-Name's problems — either by kissing her awake, killing her resident dragon, or figuring out how to spring her from the dungeon/evil stepmother/curse that's been making her life miserable.
And despite the fact that we all know that fairy tales are not like real life, many of us suffer from the Prince Charming bias. We believe that some wonderful person (or wonderful financial opportunity) will come along and solve all of our problems for us.
Not only does falling victim to this bias put a great deal of pressure on our romantic partners, but it means that we give up our own agency in financial matters. If you believe that some huge windfall is the only way to solve your money crises, you'll do what 54% of households earning less than $40,000 do: play the lottery. In fact, according to a survey conducted by the Opinion Research Corporation for the Consumer Federation of America and the Financial Planning Association, 21% of survey respondents believed that the lottery was their most practical path to wealth.
There are a couple of reasons why we have a tendency to dream about sudden wealth solving our problems. First, generally we can name recent lottery winners in our state, since local news loves a lottery winner. That triggers a cognitive bias known as the availability heuristic: Basically, we think that if we can easily recall an instance of something happening, we believe that such an event is likely. So we highly overestimate our likelihood of winning the lottery, despite the fact that we're 24 times more likely to be put to death by our state than we are to win Mega Millions.
In addition, individuals who pine for either Prince (or Princess) Charming, or for their ship to come in, are more likely to have an external locus of control. Your locus of control is how you view your ability to affect the events in your life. Those with an internal locus of control feel as though they have a great deal of control over what happens to them, whereas those with an external locus of control feel that external factors determine what happens in their lives. It would make sense for someone with an external locus of control to hope subconsciously for a solution to their problems to fall into their lap. (See also: Your Debt is Killing You)
After all, it worked for Cinderella.
Loss Aversion and the Sunk Cost Fallacy
If you regularly read advice columnists, sooner or later you'll come across a letter writer who wants to end an engagement but feels like they can't because deposits have already been paid, people will be disappointed, and Great-Aunt Hilda has already bought her plane ticket for the wedding.
Basically, these dilemmas exemplify the simple truth that Neil Sedaka told us all those years ago: Breaking up is hard to do.
Of course, there are many emotional reasons why it's difficult to call it quits when a relationship isn't working. But there is also a basic psychological underpinning behind these last-minute wedding dilemmas (and those on-again-off-again relationships that are so draining): loss aversion.
People hate to lose. We hate losing even more than we like winning. So thinking about the loss of money, face, and Great-Aunt Hilda's respect makes it difficult to clearly see the huge benefit of calling off a wedding: Not marrying the wrong person.
Loss aversion is the same reason why a gambler will double down on his losses and an investor will hold onto a sinking stock: They're both reacting irrationally to their losses. Even though it would clearly be better if they quit before they lose even more money, the money they have already lost seems too important to give up on.
This particular type of loss aversion is called the Sunk Cost Fallacy. In economics, sunk costs are the costs that have already been incurred and cannot be recovered.
If you were thinking rationally about your relationship or your investment, it wouldn't matter that you've already paid for the swan-shaped ice sculpture for your wedding reception or that you bought the stock for $30 per share while it's currently worth less than $10. In both of those cases, a rational decision would be to determine if the marriage is what you want or if your investments are currently working for you. But we all have a tendency to make current decisions based on past costs, and we hate to lose.
So, we enter into marriages we're unsure about because we can't stand the thought of losing catering deposits and we hold onto terrible investments because we're afraid of losing our original stake.
Rewrite Your Fairy Tale
Both your romantic and your financial disasters can be avoided. You simply need to rewrite your life's script.
Instead of assuming that you can change another person or influence the stock market all by your lonesome, recognize that you are only able to effect change in yourself.
Remember to take into consideration all information, rather than simply assume that things will be different from similar situation in the past.
Work to be your own agent of life change, rather than waiting for Prince Charming or the lottery to come knocking on your door.
And always be willing to cut your losses, since doubling down on a mistake will almost always cost you more emotionally and financially in the long run.
Has your love life helped — or hurt — your financial situation? Please share in comments!