Under the
SilGro home page for Alan Silverstein and Cathie
Grow
Email me at ajs@frii.com
Last update: January 8, 2021
Here are some thoughts about cognitive biases, and rational versus emotional thinking, especially as they relate to "money accounting".
Cognitive biases: There are dozens of discovered or named cognitive biases. See for example this Wikipedia list.
Stupid behavior: Cognitive biases and behavioral psychology/finance are often used to explain or demean a lot of human behavior as irrational, and thus stupid, or at least counterproductive. But this ignores the reality that: "We are not here for a long time; we are here for a good time."
Emotions count more: Ultimately the purpose of all reasoning is to (a) survive and reproduce better, and (b) feel better about our lives. In other words, mental processes (should) support the emotional ones that really bring value to our lives, and not vice versa! So it's not necessarily irrational to behave in ways that maximize pleasure, even if they don't make complete rational sense.
(Never mind that many engineers and Vulcans derive a lot of emotional bliss from rational contemplation...)
Bias against biases? Putting it differently, cognitive biases aren't necessarily "bad"... Even though it's demonstrated that despite being consciously aware of them, people still exhibit them. The best we can do is to have this mindful awareness, to try to balance reason and emotion, and to train and use both our emotional ("system 1") and rational ("system 2") decision making skills optimally. (See for example the book, "How We Decide", and this Wikipedia page.
Money accounting: Some cognitive biases affect or revolve around "mental accounting", which is (to me) how we group, categorize, or reflect upon money management, and especially how we spend money. Many financial advisors implicitly suggest strongly exercising mental accounting, such as doing budgeting; often even turning it into physical accounting, such as maintaining separate checking or savings accounts for various dedicated purposes. All of this is intended to counteract "bad habits" and poor discipline (biases) that cause people to end up unhappy due to unwise or frivolous spending.
(Such as spending the rent money on partying... "Why is there so much month left at the end of the money?")
No free lunch: But mental accounting, and especially physical accounting, come at non-trivial costs. It's greatly liberating to instead learn to treat all of your money as fungible (equally valuable and interchangeable dollar-for-dollar for whatever purpose), subject only to what I call "encumberments", such as pre-tax (qualified) retirement accounts, or capital assets that must be sold (also with tax implications) in order to make them spendable.
(It's possible to be "asset-rich but cash-poor" if it's difficult, or at least terribly tax-inefficient, to convert some of your assets into fungible dollars for spending on whatever goods or resources.)
Fungible framing: Letting go of siloing your money requires some experience, and trusting yourself to wisely balance wants and needs -- to balance frugality and impulsiveness -- both now (immediate gratification) and in the future (saving for future rewards). Also at least in principle, if you treat all of your assets as being in one large interchangeable pool, you must consider all of your resources globally every time you make even a small purchase. While it's a good idea to keep all of your assets (types of accounts) in mind while doing asset allocation and management, in practice it's ridiculous to do that every time you go shopping.
Accounting still useful: Mental or even physical accounting has a "rational" place (helping you to end up feeling better), even for "liberated, enlightened" savers and spenders. Consider an annual "fun fund" earmarked for certain kinds of joyful exchange, such as hobbies, toys, or travel. By mentally or physically segregating these funds, in balance with higher-priority "must" spending needs (and allowances for unexpected emergencies), you give your emotional self, your "inner child", prearranged permission to enjoy life more without excessive worry or guilt due to broader/deeper decision-making before each expenditure.
Simple accounting: It's not a bad idea to periodically, say annually, decide how much you can and want to spend on a given category of optional goods and services. Given this (evolving) decision, one way to manage "fun" spending with minimal effort -- not physically segregating it, nor painfully doing budgeting exercises -- is simply to log or track (like in a spreadsheet) one line at a time for each expenditure within a given category (such as travel or generosity): Date, amount spent, and purpose; with a running total.
Biofeedback: This "feedback loop" is enough to keep a wise person on track in several ways: Not overspending, not shorting yourself against total preplanned pleasures, and reminding yourself quantitatively how you're doing. It also helps you gauge what kinds of spending work out well for you (fewer regrets), versus "learning experiences" that, in hindsight, weren't ideal. Such as feeling:
(end)