How Your Mindset Affects Your Finances

Money is an abstract and complicated topic, made all the more so by a never-ending stream of financial products, such as mortgages, credit cards and student loans. So how do you make the most efficient use of yours?

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The answer is, you probably can't. At least not all of the time, according to Dollars and Sense: How We Misthink Money and How to Spend Smarter, a new book from Dan Ariely and Jeff Kreisler.

"Thinking a lot about money would be fine if by thinking more about it we were able to make better decisions. But that's not the case," the book reads. "The truth is, making bad money decisions is a hallmark of humanity. We're fantastic at messing up our financial lives."

How do you get slightly less bad with money? Recognising our shortcomings and the ways we act irrationally is one way.


According to Ariely and Kreisler, relativity is "one of the most powerful forces that make us assess value in ways that have little to do with actual value". For example, you may be more inclined to buy a $40 shirt if its tag says it's on sale from a regular price of $60, than you would be to buy a shirt normally priced at $40. In our minds, the first shirt is more valuable relative to the second one, and a better deal. But of course that isn't actually true. The "regular", pre-sale price is no longer the actual price, so should the $60 really be a consideration?

Buying "bargains", such as the $40 sale shirt, make us feel smart, the authors write, and they make decision-making easier. But rather than valuing what we think we aren't spending - $60, in the shirt example - we should consider the absolute value of what we still are spending.

Another classic example is upselling at the car dealership. If you're spending tens of thousands on a new car, it may not bother you to spend an additional $2000 on leather seats. Relative to the price of the car, that upgrade doesn't seem like that much money (especially when you add in financing).

That's because we often think about the percentage of spending, rather than the actual amount. That's why you may spend an extra $2000 on those leather seats, but not $5 on a cup of coffee on your way to work. Relative to $0, that's a lot of money.

Mental Accounting

Mental accounting is about how we compartmentalise our spending. While one dollar is theoretically worth the same as any other dollar, that isn't how we view them, depending on the mental category we've assigned it, or how it makes us feel.

For example, you may have set up spending categories with strict monthly guidelines: $250 for loan payments, $200 for food, $100 for a holiday account, $100 for entertainment and $50 for utilities, like the envelope system. Once the money for one category runs out, you stop spending, though it would be easy to "move" money from another category. It's all your money, after all.

This isn't necessarily a problem; in fact, it can be a quite useful shortcut. That's because, the authors write, it allows us to not have to consider every single opportunity cost every time we buy something. Instead of thinking about your avocado toast as money you won't have for your future mortgage, you can think of it as a money you won't have for other food purchases that week. This isn't rational, but it will stop you from going crazy.

But of course, we don't just leave it at that. While we assign the categories ourselves, we often use malleable mental accounting to trick ourselves about our spending so we don't feel as bad. We change up our own rules with suspect justifications. For example, we know we shouldn't eat out, but we do just this once because we tell ourselves we deserve it after a hard week, and maybe that $60 dinner comes out of our "entertainment" fund rather than our "food" fund.

Then there's how we feel about money from different sources, called emotional accounting. We may spend our paycheck on "responsible" things, such as rent and food, while Christmas money from Mum is spent on "fun" things, such as a new TV. It's the same thing with a work bonus or tax refund - that all feels like "extra" money that we don't necessarily have to be responsible with.


Anchoring occurs, the authors write, when we let irrelevant info affect our decision-making, and then use that irrelevant starting point "as the basis for future decisions from that point forward".

For example, you may have no idea how to value a car, until you see the MSRP. That gives you a figure to start from, regardless if it's the true value or not.

One of the ways anchoring occurs is because we trust ourselves - our judgement about the value of things - much more than we should. We base current and future money decisions on past ones. "We trust that we've made a specific value decision over and over, we assume it was a good one," the authors write:

Once we pay $4 for a latte and $50 for an oil change, we're more likely to do so in the future, because we have made this decision before, we remember it, and we're partial to our own decisions - even if it means paying more than we need to. Even if there's a place offering free coffee while we wait for our $25 oil change.

Another example of anchoring that can influence your financial life: Salary negotiations. In negotiations, the first number thrown out has a ton of power - there are plenty of advice articles telling you not to give the first figure in case you undercut yourself (particularly for women), or to give an intentionally inflated figure before your potential employer does so that you're in control of the process.

But anchoring doesn't have quite a pronounced effect when you know a bit about what you're buying. For example, a real estate expert is less likely to be swayed by the listing price of a house than someone who isn't an expert. Alternatively, we can trust ourselves less.

What You Can Do About It

Ariely and Kreisler's book says that self control is one of the keys to harnessing our finances, a concept they acknowledge is easier to talk about than to execute.

Managing our personal finances "responsibly" is intended to set our future selves up for success. And that future self can often feel like a stranger - thus why it's easier to splurge on something now or not may contributions to your superannuation.

To make future you feel more like, well, you, you need to make this person "defined, vivid and detailed". One way is through having conversations with your future self. Another is to pick a specific retirement date (if that's the goal you're having a hard time making progress toward) rather than an amount of time. Say, 1 February 2058, rather than "in 40 years". The authors also suggest "meeting" a computerised version of old you as a way to build empathy.

That may seem a bit strange, but there are other ways they suggest as well. Automation, for one, assuming you have enough funds to do so. Guilt works, too (the book cites a study by Dilip Soman and Amar Cheema of the Rotman School of Management that found people spent less when envelopes of money had their children's names written on them, because they felt bad about it).

You could also try reward substitution. Instead of forcing yourself to think about future you all the time, think of some small reward you could have now if you complete the tasks you need to. For example,

Some states are doing just that by offering "lotteries" for people who put money into savings accounts. Each deposit is greeted with a ticket that offers a small change of winning an additional amount of money. These lottery-based savings plan work.

For you that might be treating yourself to a movie when you make a payment toward your credit card debt, or something similar.

Obviously these tactics won't solve all of your problems - so much of money isn't affected just by your personal behaviours, but by a system created to be opaque and confusing in many situations. It is, however, a good lesson in the ways we can start training ourselves to think smarter when it comes to our money.


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