In this article, you will:
- Understand the psychology of money
- Break the paycheck-to-paycheck cycle
- Learn the steps in building an emergency fund
- Discover how to control your spending
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Understanding the Psychology of Money
If you haven't heard the story of Grace Groner, it is a rather unique story. While there isn’t anything adventurous and dramatic about her life story, other than her being an orphan at the age of 12, she lived a simple life. Living in a small cottage and buying clothes at rummage sales, upon her passing in 2010, she donated over $7 million to her charity.
How is it that someone is living a simple life not to spend money frivolously?
Sounds simple but consumers whine when they can’t upgrade their phone every few years. Grace is an example to us all. Her simplicity proved that money isn’t everything. She was deeply loved and admired in her Illinois community. What was her secret? Well, she worked at Abbott Labs for approximately 43 years and bought some stock. Over the years this stock grew, split, and paid dividends. While this contributed to her wealth, the real secret is her ability to live beneath her means. She managed to keep expenses simple while affording to donate money regularly to those in need.
When I worked for an investment firm, I was informed of a gentleman in his mid-30’s who retired after saving and earning around $27 million. So anxious about his new profound freedom, he bought a new house and yacht for his family with intentions to travel the seas. Fast forward five years, and he was looking for a job. He had lived above his means that his $27 million nest egg dried up like a desert lake.
If history has proven anything, it is that there is never enough money. With the stories readily available about kings and rulers, their greed always managed to leave them empty-handed eventually. The psychology of money is really about the behavior of one’s ability with cash. Our spending behavior often mirrors how we view money.
What do I mean? Well before the last 50-70 years, owing the debt to someone was rare. The thought of credit was an ugly term and saving money was always the goal. While we still try to keep money in today's environment, our culture has rewired our minds to believe that if we can afford the payments, then we can provide that item. What our brains should be telling us is if we can pay cash for it today, then we can afford it as long as we aren’t sacrificing anything.
We need to rewire our brains and get out of the short-term thinking when it comes to money. Maybe we don’t need that sweater or lawn mower on sale. Perhaps we can find similar items at a fraction of the cost at a garage sale or online auction.
Break the Paycheck-to-Paycheck Cycle
During the U.S. government shutdown in December 2018, we witnessed something terrifying about the shaping of the culture when it comes to finances. CNBC reported that approximately 800,000 federal employees were potentially put into financial distress. It forced them to reach into their savings, use their credit cards, and possibly stop funding their retirement.
Some may argue that they do not make enough money and if they made more, they wouldn’t have financial troubles. It has nothing to do with how much one makes. ”It’s not merely those earning low wages who are struggling. CareerBuilder reports that nearly 10 percent of Americans with salaries of $100,000 or more live paycheck to paycheck as well.”
Sol Smith is a 40-year old male who lives in Laguna Niguel, California. Despite having advanced degrees and being very successful as he is the chair of liberal arts at Southern California College, his family lives by each paycheck. He tells the Washington Post "I am 40, have built a strong career, have 17 years experience, and if something were to happen to me, my wife and kids would be homeless within a year when my life insurance ran out.”
While this may be true for a small percentage of the population, the rest of the homesteads it reflects poor money management skills. Some can blame the education system as it continues to fail in teaching students how to manage money. For instance, student loan debt has totaled its highest point ever, over $1 trillion. Credit card debt is the second highest after student loans for delinquency.
The mindset of credit has forced the economy to live on debt. Approximately 80% of U.S. consumers live paycheck-to-paycheck because they are paying out more and earn.
So how does one this cycle? It’s a tough journey and one that requires discipline and a change of heart. The form of control will come in the forms of stopping using all credit cards, lower your expenses, and find ways to increase income. Over time, you will see results as your expenses and income will emulate a teeter-totter.
Steps to Building an Emergency Fund
Should every home have an emergency stash? Each family should have readily available funds for such situations. For instance, automotive trouble to get your car working so you can commute to work or a home repair where the roof is leaking or a/c went out may cause for extra funds to be needed. Window shopping and seeing sales is not an emergency.
The purpose of an emergency fund is to avoid using credit whether it is a credit card or one’s Home Equity Line of Credit (HELOC). This is because more debt to fix an issue might be comfortable and convenient but is dangerous and must be avoidable.
Building an emergency is the start of saving 3-6 months of living expenses. By setting a goal to collect a minimum of $1,000, you get the money snowball process going. By reaching the first $1,000, you have a milestone to reach. Now the trick is to work backward. Determine how soon you want to have this amount and divide it by the number of pay periods. For example, $1,000 divided by 8 pay periods equals $125 per paycheck should go towards your emergency fund.
Note: If you have taken the necessary actions above in reducing your expenses and still struggle in saving money to build an emergency fund, read this blog:
Once you reach this goal, it is important never to touch the funds until it is a real dire emergency. If possible continue adding funds to this account until you can safely build 3-6 months of living expenses. Your living expenses are accurate as it reads. It is how much you need each month to eat, have shelter, and pay your bills. You might be surprised to learn it is more than you thought you might need.
Control Your Spending
Now that we have discussed ways to cultivate a habit of saving money let’s explore ways to control spending money. Expenses have a way of creeping up on us. Last month I conducted a Financial Spring Cleaning of my budget. As I practice what I preach, I managed to reduce a few bills and cut out a few expenses. This month, I received several offers of “Free 14-Day Trial” or “30 Days Free” on several business products that I use to promote DollarOtter, as well as, entertainment expenses.
Having read the disclosures closely, these offers do allow me to cancel risk-free during the trial period. If I fail to make a calendar reminder to cancel this, I am putting my finances at risk of about $40-$60 per month after the trial expires.
It is these little offers that entice us to sign up. Marketers get paid billions of dollars to find new creative ways to make consumers “want” their products. They are very good at it too!
By limiting access to promotional emails or pop-up sale banners, this can be a start. I use Gmail for much of the business’s service, and any promotional emails are sent to a separate folder. I call this “out-of-sight, out-of-mind.” It is a layer of protection I added, so I do not fall prey to their marketing tactics.
Next, ensure you are making and sticking to a budget. It is easy to create a financial plan from month-to-month, but the hardest part of this action is actually following it. From spreadsheets to apps, determine which method works best for you.
Third, if you struggle with the temptation of spending more with your debit or credit card than you do with cash, start using real dollars to pay for items.
Last decade, a team of researchers conducted a study on the brain’s effects of using credit versus cash payments. The study was published in the Journal of Experimental Psychology, and the results were quite an impression. The consumers paying for items using credit cards experienced little pain when spending money compared to shoppers paying cash. These shoppers using cash payments experienced more pain as they visually saw the cash outflow. The researchers called this ‘pain of paying.’
Their researchers also discovered that consumers who used credit cards spent a more significant proportion of impulsive purchases and more unhealthy food items.
The moral of this story is to use cash for almost anything you can because it hurts. The pain will help you become more disciplined when it comes to better money management and saving money. You might also think twice before making those purchases that may be deemed as unnecessary or irrelevant.