Hard-headed in money matters

Question: Why are we so hard-headed? It’s not that we do not know the rules in becoming rich. These rules are being taught at home, in schools, and now by the legion of financial planners in the country. Yet, we still do not follow them. What gives? —asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph and Facebook.

Answer: Sometimes, it is not an issue of people being hard-headed.

The human brain is programmed to behave in an efficient way so that it does not use up all your energy (in the form of glucose) that may still be needed by the other parts of your body.

In a way, you can look at getting a headache from thinking too much as the body’s warning signal that you are already spending too much energy.

This need for efficiency is highlighted by the fact that the brain needs to make so many decisions in a day. These decisions cover all sorts of topics from the most inconsequential like choosing which soda to order at a restaurant to those that are life-changing like choosing a career. But for the most part, decisions that the brain needs to make are in the realm of the inconsequential. Therefore, in an effort to conserve energy, the brain typically applies shortcuts, rules of thumb if you will, to make decisions regarding minor topics.

The brain is so dependent on these shortcuts that sometimes, even when heavy thinking is already needed, it is still using the shortcuts. At the same time, retailers study very well the brain’s favorite shortcuts and uses them in selling their goods and services.

So, while a person’s being hard-headed can be a result of his natural overuse of shortcuts, it can also be because of the tricks that retailers play on the brain.

In our upcoming book, “Taming the Rebellious You – Using Your Brain’s Natural Disposition to Enrich Your Finances,” my co-authors and I identified some of these shortcuts that would lead to mismanagement of the four pillars of personal finance, that of cash, debt, risk and wealth.

In terms of cash management, particularly in saving, we cited that the brain has a natural disposition to avoid losses because it is part of survival. Therefore, any attempt to save is translated by the brain as a loss of part of its lifestyle. That is why asking a person to save 20 percent of his income will usually not work because, phrased this way, saving is interpreted as an outright loss.

Behavioral economists say that the way to solve the saving problem is to frame the issue in a way that the brain interprets it as a foregone gain. And believe it or not, just asking a person to live off 80 percent of his income will often do the trick. This has been proven not only in experiments in the United States but also by our training participants after they applied this kind of framing.

Still on the matter of avoiding losses and now debt management, the brain will go for lower interest loans when it needs to borrow. Retailers have devised the add-on-rate, which makes loans appear inexpensive when interest rate is quoted on a monthly basis. A 20 percent, 5-6 loan may look inexpensive. However, if it is a loan where the interest is always an absolute 20 percent of the principal repaid over a short period, the interest can reach up to 332 percent a year effective (e.g. P1,000 repaid P30 daily for 40 days). Now see if a person will still borrow under 5-6 if prior to loan release, the lender discloses such huge interest (and not just 20 percent).

Similar situations affect risk and wealth personal finance management. Let me tackle these in a succeeding column.

Now don’t think that complex rules, logic and values are all that are needed to overcome such “hard-headed” behavior.

The brain will not apply complexity because of its overriding need to be efficient.

The solution is to come up with equally simple rules or shortcuts based on the brain’s natural disposition.

In the case of saving earlier, the solution was to frame the challenge as a foregone gain.

We are naturally hard-headed for this is part of our DNA. We just need to learn how to use that hard-headed quality in better managing the four pillars of personal finance of cash, debt, risk and wealth management.

In this regard, may the fours be with you.