The basics of sound money management are so simple they could fit on an index card, experts insist. We all know to live below our means, max out our employer-sponsored retirement accounts, and avoid credit card debt. Yet many of us struggle to get our finances under control.

Why?

The short answer is emotions. Humans aren't Vulcans. We carry around irrational fears, unhealed wounds, and hidden assumptions that can make choosing wisely much harder than it should be. Finally getting a handle on your finances is as much about confronting the weird emotional baggage we have about money as it is about whipping out the calculator and a pile of receipts.

Thankfully, if you're just everyday levels of conflicted, that probably doesn't meant a long relationship with a therapist. In fact, a single question might be enough to get you a more clear-eyed view of your financial situation and the underlying attitudes that are complicating things for you, Melissa Dahl contends recently on Science of Us.

The Illusion of Wealth vs. The Illusion of Poverty

Drawing on new research in the Journal of Marketing, Dahl claims that nearly everyone fits into two broad categories. "Either you are (to varying degrees) under the 'illusion of wealth' or the 'illusion of poverty,'" she asserts. To tell the difference just ask yourself this simple question: "Would you rather have $1 million total saved for your retirement or $5,000 to spend every month?"

As the math whizzes among you will instantly note, this is actually a trick question. Both alternatives are effectively the same. The current rule of thumb is that you can divide the lump sum you have saved for retirement by 200 to get your monthly annuity payment. That means having $5 million in the bank at 65 is pretty much the same thing as receiving $5,000 a month from the same age. So why is this question revealing?

If you chose the lump sum

Rationally we should have no preference between the two scenarios, yet most of us do, and our preference reveals plenty about our attitudes towards money. If the big lump sum appeals to you, Dahl explains, that probably means you're inclined towards a false sense of security about your finances. Chances are you don't worry enough.

People who opt for this choice suffer from an "illusion of wealth." Once they have a healthy-looking number saved, they fail to do the basic division that will tell them how much that comes out to monthly, or they underestimate how much they'll need to maintain their lifestyle. Either way, they end up coasting and saving too little. But if you know that's your tendency, you can correct for it.

If you chose the monthly amount

The opposite is generally true of those who go for the monthly payment. These folks tend to be too worried about covering their monthly bills and fail to invest in things that can advance their careers and improve their lives now. Sometimes skimping on taking that class or investing in that business opportunity will actually leave you less well off in the long term. The "illusion of poverty" people in this group need to be on alert for these sorts of mistakes.

The study authors make the practical suggestion that financial planners and websites should present retirement savings to customers in both formats, helping everyone avoid their biases. But until that happens, "knowing that each of these illusions exist -- and getting an idea of which one might describe your beliefs and behavior -- is at least a start," Dahl concludes.

Are you more prone to the illusion of wealth or the illusion of poverty?

Published on: Apr 6, 2017