The way we spend money is often based on our emotions and experience. Money has been linked to our sense of security, power, and freedom among other things. Thus, how we feel about money affects how we behave with it.
There are different behavioral economics theories that try to explain how we relate to money. The first one is mental accounting which is the categorization of our money. We have different accounts such as savings, disposable income, credit, among others. The idea is that we spend money differently based on the account it comes from.
Another theory is loss aversion. This is the idea that we feel more pain losing money than the pleasure we get from gaining the same amount. This means that we might avoid certain investments that might lead to a loss even if the probability of gain is higher.
Then there is the Herding Effect, which talks about the impact of social pressure on our spending. We tend to follow what others do in terms of spending money. This means that we could overspend on certain items and avoid others because of the trends that we experience or see around us.
Emotions such as anxiety, fear, and envy can also lead to poor financial decisions. For instance, anxiety can lead to hoarding money or avoiding certain investments. Fear can make us less risk-friendly which could limit our earning potential. Envy can create feelings of dissatisfaction with what we have and hence lead to bigger and unnecessary purchases.
In conclusion, financial decision-making is tied to our emotions and experiences. By understanding the psychology of money, we can make better decisions that align with our financial goals.
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