The Surprising Factors That Cause People to Make Poor Financial Decisions

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Everyone makes bad decisions from time to time. Making mistakes is part of what it means to be human. And if there’s one category where a majority of Americans continue to mess up, it’s personal finance. But there’s some good news: Many of the mistakes you make with money can be prevented by simply understanding and reversing some surprising factors that influence your final decision making.

Don’t Let These 5 Factors Hold You Back

As wealthy and successful as Americans are compared to the rest of the world, we aren’t nearly as well off as we could be. Consider that 20 percent of Americans don’t save any of their annual income; more than 40 percent of Americans have less than $10,000 saved for retirement; two-thirds of Americans can’t pay for a $1,000 emergency in cash; and the 68 percent of American households don’t have a monthly budget.

In some cases, this comes down to a lack of income and extenuating circumstances (like poor health). But in most situations, these statistics are the direct result of poor decision making. And surprisingly, the following negative influences are squarely in play.

  1. Sunk Cost Fallacy

A sunk cost is something that’s already been paid and can’t be recovered under any circumstances. In a perfectly rational world, we wouldn’t let sunk costs impact future decision making. But in the faulty world in which we live, we often let the sunk cost fallacy influence us to throw more money at lost money.

The sunk cost fallacy can rear its ugly head in multiple ways. You’ll often see it when a person makes an investment into a stock and doesn’t sell, even when the price collapses over a period of many weeks and months. The desire not to lose money is so strong that the investor will actually risk losing everything just to be right.

In a more lighthearted scenario, you might see the sunk cost fallacy play out with a gallon of spoiled milk. Rather than throw the spoiled milk out, someone might decide to pour it on their morning cereal simply because they want to get their money’s worth. In reality, the money has already been spent regardless of whether it’s used or not. At this point, using it only makes your situation worse.

  1. Lack of Sleep

According to a study conducted by the American Academy of Sleep Medicine, sleep deprivation adversely impacts a person’s decision-making at a gambling table by elevating their expectation of gains and lowering the perceived severity of losses following risky choices. And unfortunately, this carries over into areas of personal finance and money management that extend beyond the casino.

If you’re like most Americans, you don’t get enough quality sleep. As a result, your brain finds it challenging to clearly weigh risks and benefits and make wise decisions. The only solution is to get better sleep on a regular basis. Doing so will mentally refresh your brain and enhance clarity.

  1. Hunger

If you’re tired and hungry, you’re in big trouble.

“One of the funny things about how our bodies work is that sometimes feelings or states of being can spill over from one area to another. Our physical desires work like this,” entrepreneur Belle Beth Cooper explains. “If we’re feeling hunger, thirst or sexual desire, for instance, that can actually spill over into the decision areas of our brains, making us feel more desire for big rewards when we make choices. This can lead us to make higher-risk choices and to want for more…”

This is why it’s never a good idea to make a big decision on an empty stomach. Avoid making big decisions in the hour leading up to lunch or dinner. Instead, the best time to make a financial choice is mid-morning or afternoon.

  1. Aspirational Wealth

When it was published in 1996, Thomas J. Stanley’s The Millionaire Next Door presented groundbreaking conclusions to the general public. The basic takeaway from the book is this: Wealthy people reject lifestyles of opulence and flashy living and instead practice very deliberate and moderate spending, saving, and investing. Furthermore, poor people often find themselves in bad financial situations as a result of embracing “aspirational wealth.” In other words, they try to spend their way to the top, which only serves to burden them with debt and prevent them from truly creating wealthy.

If you want to become wealthy, you have to be willing to sacrifice some short-term pleasures for long-term gains. This means saving and investing your way to wealth, as opposed to spending in an effort to look wealthy.

Make Better Financial Decisions

You don’t need to earn a six- or seven-figure salary to establish financial security and build wealth. While it’s helpful to earn more, no amount of money will ever be enough to counteract poor decision making. Instead, you should shift your focus to making smarter choices that allow you to avoid mistakes and maximize your potential. This is where positive change happens.

 

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