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Okay, have you ever heard of this mythical creature called the “Homo economicus”? It’s this idea that there’s a perfectly rational, all-knowing human being out there who always makes the most effective decisions to maximise profits. Yeah, right!
You and I both know that this perfect person doesn’t actually exist in the real world. You’re human, just like me. You experience emotions, you don’t always have all the info, and you make imperfect choices sometimes. That’s just being human, my friend.
But here’s the thing: a lot of people tend to forget that when it comes to money and finance. They act like they should be able to make flawless decisions all the time. Well, news flash: that’s just not realistic!
That’s where behavioural economics comes in. It’s all about understanding how our human tendencies and imperfections influence the financial decisions we make. And trust me, once you understand these psychological money traps, you’ll realize just how often you’ve been falling into them without even realizing it.
Table of Contents
6 Middle Class Money Traps
Money Trap 1: Limited Squares (The Scarcity Mindset)
Yo, let’s talk about the first money trap that’s got you stuck in a rut – the scarcity mindset. It’s like your brain is a tiny apartment with only three rooms, and when one of those rooms gets occupied by worries about bills or money troubles, it leaves you with less mental space to focus on other important stuff.
A. The concept of mental bandwidth and cognitive ability
Think of your mental bandwidth or cognitive ability as three empty squares. Each square represents something you can really focus on at any given time. When something big happens, like a bill coming due, one of those squares gets filled up, limiting your ability to concentrate on other things.
B. The impact of financial scarcity on decision-making
As each square gets filled, you become more prone to the scarcity mindset, which reduces your overall cognitive ability to solve problems or retain information. This mindset makes you more impulsive and more likely to make poor financial decisions.
1. Research study: IQ test performance and financial scenarios
A research study by Princeton psychologist Eldar Shafir found something fascinating. He gathered a group of students and asked them to complete several IQ tests while thinking about different financial scenarios.
In Scenario A, they had to imagine driving a car and then it needed a simple repair costing $150. In Scenario B, the repair cost a whopping $1,500 – ten times more! He then sorted the participants by household income.
Guess what? Those who were in the middle class and above did well in both scenarios, but those considered poor performed differently. The poor group did well with the $150 repair scenario A, but their IQ scores dropped significantly for the $1,500 scenario B.
Thus, The researchers found that people who have some sort of emotional or financial constraints tend to score lower on the IQ tests due to cognitive limitations or the three squares being filled. The scarcity mindset can lead to anxiety and poor decision-making, like taking on high-interest payday loans that seem like a quick fix but end up costing a ton of money in the long run.
C. Strategies to overcome the scarcity mindset
Don’t worry, though! You can change this mindset by doing one simple thing:
it’s actually giving yourself a break, now you can’t actually increase the number of squares that you have, but you can cut out things that are taking up mental space, small things like
1. Automating payments and reminders
Setting up automatic payments and reminders can help cut out things that are taking up mental space and free up your mental load.
2. Building an emergency fund
Start building up your emergency fund, and you won’t have to constantly obsess over every last penny.
3. Creating a standard routine or just stopping pointless activities.
It’s easier said than done when you don’t have much money to start with, but fixing the next money mistake can help tremendously.
Money Trap 2: The Obscure (Ignoring Opportunity Costs)
okay, Everything you do in life whether that’s eating a cheeseburger or watching a movie has a cost and no i’m not talking about the actual cost of that activity, but instead a cost that you can’t see, i bet that you didn’t know that everything has a hidden price called the opportunity cost, sounds scary right? well it is, because not knowing these hidden costs is one of the biggest financial mistakes that people make without even knowing it.
Opportunity Cost means the loss of value or benefit when you choose one option over another option in the decision making. It’s a hidden price tag that comes with every decision you make in life, whether it’s eating a cheeseburger or watching a movie.
A. The $6,000 cheeseburger example
Let’s break it down with an example. Say you’ve got $6,000 burning a hole in your pocket, and you’re feeling pretty good about yourself. You’re like, “I deserve to treat myself!” So, you decide to splurge all of your money on the most expensive cheeseburger in the entire world – a whopping $6,000! Now, that’s totally ridiculous, but bear with me.
The $6,000 you spent is the actual cost of the cheeseburger, but the opportunity cost is what you could’ve done with that money instead. You could’ve gone on a fancy vacation, invested in your business, or even bought a really nice red brick (hey, no judgement here).
What you do need to know is that $6,000 is now done, it’s no longer in your possession “nada” and all the other opportunities that money could have been spent on no longer exist. now here’s what will blow your mind
1. The real cost: Compounding interest over 30 years
But here’s the kicker: that cheeseburger actually cost you way more than just $6,000. If you had invested that money instead, at an average rate of return of 8% over 30 years, you’d have ended up with a whopping $60,000! That’s enough to buy a brand-spankin’ new Tesla Model 3.
B. Evaluating alternative opportunities for money
See, every time you spend money on something, you’re giving up the opportunity to use that money for something else. That’s why it’s so important to think about the alternative opportunities for your hard-earned cash before making a purchase.
Was that cheeseburger really worth missing out on a Tesla? Probably not, right? The best way to take advantage of opportunity costs is to invest your money wisely, like with a cool stock trading platform called Moomoo.
Money Trap 3: The Settled Trap (Sunk Cost Fallacy)
Pay attention because it can actually get really confusing, if you buy something and that cost has already happened, meaning that the transaction went through and the money is no longer recoverable, then that cost shouldn’t influence any future decision, what the heck. okay here’s, an easy example:
Yo, have you ever stayed in a movie that was so bad, it made you question your entire existence? Like, why did someone spend millions of dollars to make this pile of trash with flying sharks? (We’re looking at you, Sharknado!) But instead of leaving, you stuck around because you already spent ten bucks on the ticket, and you didn’t want to “waste” your money.
That’s what we call the sunk cost fallacy, my friends. It’s when you justify sticking with something, even though it’s not worth it anymore, just because you’ve already invested time, money, or effort into it.
A. The irrational tendency to justify past decisions
The sunk cost fallacy grips our minds with its little irrational claws, making us think we need to get our money’s worth, even though the cost is already gone and can’t be recovered. It doesn’t just apply to movies, either. The sunk cost fallacy also applies to other areas, Such as your job, you’re sitting at your desk or drinking all the free mediocre coffee you want but, then one day at work you feel empty, you feel like something inside is missing you’re thinking that perhaps you made the wrong decision and that this job makes you miserable, you just say screw it and start from scratch somewhere else.
No of course not, you probably stay, in your mind, you already invested years and years of your life into this current job and you think that you’d waste all those years, if you switch to something else. That’s the sunk cost fallacy at work, too.
B. The opportunity cost of sunk costs
The sunk cost fallacy is this invisible anchor that’s tied around your leg pulling you in deeper and deeper, unless you actively untie it, again it also goes with opportunity costs.
But here’s the thing: by sticking with something just because of the sunk costs, you’re actually wasting more time and missing out on other opportunities. Because there’s always that what if, what if you had left that terrible Sharknado movie after 20 minutes – you could’ve done something way more enjoyable with your time!
Not understanding sunk costs can warp your perception of value, and that’s not even the worst part. The next money trap can actually leave you financially ruined forever. Yikes!
Money Trap 4: The Exchange (Transactional Utility)
Damn that’s a lot of text, this one might sound like academic jibber jabber but it’s quite simple, This is Transactional Utility.
A. The psychological trick of discounts and “good deals”
Yo, have you ever heard of something called “transactional utility”? It might sound like a bunch of fancy words, but it’s actually a sneaky psychological trick that companies have been using for centuries to make you waste your hard-earned cash.
In the U.S.A we even have a whole day dedicated to exploiting you right after you spend a whole day celebrating everything you’re thankful for,
Black Friday, where hundreds and thousands of greedy people push, shove and pummel one another for a discounted Item.
B. The example of the 30% off magic lamp
Imagine this: you’re strolling through the supermarket, just trying to grab some ingredients for a delicious cheeseburger (no lettuce or tomato, of course). But then, you spot a huge red sign advertising a brand-new “Mr. Magic Lamp” at a whopping 30% off! Wouldn’t you at least be tempted to check it out?
You might even end up buying that lamp and forgetting why you went to the store in the first place! You’d go home feeling like you scored the deal of a lifetime and saved a bunch of money. But in reality, you didn’t even need the lamp at all.
C. Recognizing unnecessary purchases driven by discounts
See, research shows that what you buy isn’t just about the value of the item compared to its price. It’s also heavily impacted by your perception of a “good deal.” If you believe you’re saving money by making a purchase, you’re way more likely to buy it, even if you didn’t originally want or need that thing.
This is great when you get a discount on something you were already planning to buy. But it gets really dangerous when the discount itself convinces you to make unnecessary purchases, like that magic lamp, which you definitely don’t need (unless you’re a real one – in that case, comment “Mr. Magic Mustache Lamp” below).
Money Trap 5: The Cognitive Count (Mental Accounting)
A. Explanation of mental accounting and separate “money buckets”
Yo, if you’re one of those people who budgets their money by keeping separate mental buckets for different expenses, then you’ve been bamboozled, my friend! This way of keeping track of your expenses is called mental accounting, and it’s when you track your spending based on which mental bucket the money is coming from, instead of treating all your money as one big pool.
B. The research study: Ticket scenario and willingness to spend
Now, pay close attention to this famous research study because the results will blow your mind. The researchers gave participants one of two scenarios. In Scenario A, they had to pay $10 for a $10 ticket that they lost. In Scenario B, they had to buy a $10 ticket after losing $10.
The study found that in Scenario B, where they lost the $10 bill, a whopping 88% of people were likely to buy the $10 ticket. But in Scenario A, where they lost the $10 ticket, only 46% bought another ticket. The researchers were shocked by these results!
C. The fallacy of assigning different values to money sources
Here’s why: it doesn’t make much sense to see such a huge gap in numbers when the amount of money lost and spent was the same. But then they realized this is the fallacy of mental accounting. You subconsciously categorize money into different buckets with different values, and you naturally overvalue or undervalue certain ones.
In this case, some participants had a mental “entertainment” bucket, so after losing the ticket, they didn’t want to spend more from that bucket. But at the same time the $10 bill that was lost didn’t belong to a specific category, since it was a general $10 bill with no categorization and therefore it wasn’t impacted by any value factor, so they were more willing to spend it.
Example: Tax refunds and bonuses as “free money”
When mental accounting is applied, irrational decisions are often made, leading to really bad, wasteful spending over the years. And I bet you tree fiddy that you still mentally account for money sources like work bonuses or tax refunds. People tend to categorize these as “free money” and then recklessly spend it on things like a $6,000 cheeseburger or a Mr. Magic Lamp, because they mentally assign a different value to it than their regular paychecks.
D. Teaser for effective budgeting strategy (Instagram DM)
That’s why companies roll out a ton of tax refund sales and discounts from late January to early May. At the end of the day, the value of money is the same. Mental accounting is better than nothing, but it’s a mistake that will get worse if you let it go unchecked. If you want to know my most effective strategy for budgeting your money, follow me on Instagram and DM me “sloths”. My Instagram link is in the description below, and I’ll send you my strategy.
Money Trap 6: Postponement (Delaying Gratification)
This all began with marshmallows, what does? The biggest money mistake that you’re making right now, and a big predictor of your future wealth.
A. The Marshmallow Experiment and its implications
Back in 1972, there was this famous experiment called the Marshmallow Test, which
became a staple in every college psychology course. Researchers gathered a group of kids and then gave little kids a marshmallow and told them they could either eat it right away or wait a bit and get more marshmallows. The kids who were able to delay their gratification and wait for the bigger reward showed they had the discipline to overcome immediate pleasure for a larger future payoff.
B. Prioritizing short-term vs. long-term rewards
Example: Uber vs. public transportation
Now that you Know, this ability to delay gratification is key to financial success. Think about how you get to work every day – by Uber or public transportation. Taking an Uber seems nice for the immediate comfort, but it comes at a premium cost. The alternative is delaying that gratification – taking the bus instead, saving that money, investing the difference, and growing it until you can buy your own car down the line.
C. The importance of delayed gratification for financial success
The Marshmallow Test revealed that the kids who could wait for more marshmallows were far more likely to be successful as adults. The simple reason? They had the discipline to overcome impulsive desires for immediate pleasure and instead prioritise bigger, long-term rewards – which is crucial for achieving financial success. Delaying gratification and focusing on the future payoff rather than short-term rewards is key.
Conclusion on Middle Class Money Traps
Alright, let’s be real here. I’m not saying that I’m immune to these money traps myself. Even after studying all this stuff, I still catch myself making some of these irrational decisions from time to time. We’re all human, after all.
But the key is to keep striving to improve and to be aware of these traps so that you can avoid them as much as possible. Because falling into these money pitfalls can seriously derail your long-term financial success and wealth-building efforts.
So, do yourself a favour and keep learning about this stuff. Follow me on social media, sign up for my newsletter, or whatever works for you. The more you understand these behavioural economics principles, the better equipped you’ll be to make smarter money moves.
It’s an ongoing journey, but it’s one that’s worth taking if you want to achieve true financial freedom and security. Stay woke, my friends!
