Money and psychology are often interrelated. One area in which the two come together is in the case of cognitive dissonance. It’s a phenomenon that’s applicable in many areas of life, but it can occur in the world of money and personal finance as well.
First off, why am I bringing up the topic? I’ve been thinking a bit lately about the notion of being persistent and how it can be an important aspect of trying to increase net worth, and the role it plays. One aspect of this is being persistent with trying to remove barriers to success, including those are more psychological in nature.
Anyway, this brought to me the concept of cognitive dissonance. This essentially refers to situations where a person might have two thoughts, ideas, or concepts that are in sharp contrast to one another. This contrast can result in frustration, anxiety, irritation, or other psychological conflict. The person is then motivated to try to lessen this dissonance through modifying beliefs or creating new ones.
Here’s an example, outside of personal finance: a person who likes to eat fast food on a daily basis. The person enjoys trips to fast food establishments, but also realizes that such food is not the most nutritious. With those conflicting thoughts, the person might rationalize how he’s healthy anyway so it won’t affect him, or that there is too much hype regarding supposed negative consequences to fast food. Or, in one case I actually heard someone say years ago, “When I get old, there will probably be a pill to cure anything anyway”.
How can this apply to personal finance? Here are 4 ways that cognitive dissonance can impact our money decisions:
Cognitive Dissonance and Shopping
- A person buys a new car, without reviewing any published ratings, and has issues with it
- A friend buys a new car, talks about how well it rated, and has no issues with the car
- The first person rationalizes that the other person is more knowledgeable about cars anyway, so he probably knew what to buy instinctively
Cognitive Dissonance and Real Estate
- A home buyer falls in love with a home and stretches to take out the maximum loan she will be offered
- She knows that stretching to buy a home can be quite risky for one’s finances
- She then decides that most people have dreams that mean a lot personally, so it’s okay to sometimes just go for what you want – and this was one of those times
Cognitive Dissonance and Investing
- A stock buyer pays $50 per share for an investment in a company
- The stock price drops to $45 per share on bad earnings reports, prospects for the company don’t look very good, and most analysts think the stock has the potential to drop much further
- Despite this news, the investor decides to hold on to the stock with the belief that what goes down usually comes back up – carrying out the disposition effect in the process.
Taking these examples into account, I’ve been thinking of this concept in terms of building wealth. My approach to this has been to think positively, though occasionally I slip into the following thinking:
- I would like to have enough wealth someday to have freedom and financial independence
- However, I’m seemingly a long, long, way from getting to that point.
- Therefore, I sometimes think “Well, many people end up working later in life than they want to anyway, so it wouldn’t be so bad or unusual if that ended up happening with me”.
See the issue here?
It’s gotten me to think that being able to side step such thinking can potentially be quite helpful in reaching goals. Being able to utilize critical thinking skills can be a better approach.
What I’m suggesting is to stop and analyze a situation for a moment, and:
- Identify if we’re facing such conflict
- Think through, with an object mind, different points of view
- Come up with a better path for us to take with our actions
For example, in the situation above, instead of just capitulating to the thought of working later in life, why not take a view such as this: “It’s going to take focus, determination, hard work, and perhaps a little luck – but if I put my mind to it, I can do it. After all, others are able to do it!”
Bottom line is that we shouldn’t let psychology stand in the way of success. Rather, let us find ways to use an understanding of psychology to help us reach our aspirational goals!
My Questions for You
Have you experience this phenomenon when it comes to money or in other aspects of life?
Have you seen any others display this tendency?
How do you think we can use critical thinking and psychology to help us make good decisions, assess situations effectively, and move forward to achieving our goals?