Why do some people make such bad financial decisions? We don't save enough. (A recent BankRate study shows that 36 percent of Americans aren't saving for retirement.) We spend too much. (Consider all the credit card debt). When we invest, we try -- in vain -- to "beat the market," paying silly fees to experts who dangle the prospect in front of us, but rarely deliver. When we borrow, we do so at ridiculously high interest rates.
It may have to do with how people perceive time.
I spent nearly 15 years in banking, and I have often asked people about their biggest financial mistakes. I hear stories like these:
I was out drinking with my friends. I decided to buy everyone a round. And then another. The next morning I woke up with a headache and a bar bill I couldn't afford. That seemed to happen every weekend, until my credit card was maxed out.
When I am in a store, I just can't stop myself.
I knew how much I should have spent on my home. But I saw an amazing house down the street with granite counters. I could just imagine our family living there -- so I bought it.
I know I should make more time to look at my investment portfolio, but I just don't have the time. And, when I heard that everyone was investing in that fund, I just decided to follow the crowd.
All too often, we have the financial understanding necessary to make the right decisions, but we don't. To understand why this happens, and to see how we can help people make better decisions, I reached out to Dr. Philip Zimbardo, a psychology professor at Stanford University. I was a student of his and felt honored to be able to work with him. He's famous for the Stanford Prison Experiment, but he has also been studying our time personality for more than 40 years.
In an ideal world, we would have good memories of the past. We'd have an ability to enjoy the present. And we'd plan for the future. But, often, our approach to time can get out of balance:
You can get stuck in the past. If something bad happened to you in the past, you can have an excessively negative view of the past.
You can get stuck in the present. When we are born, we enter the world perfect little hedonists. We want everything now. We don't care about the consequences of our actions. Over time, most of us learn that there are consequences, but some people don't and just want to enjoy the present. These people are the life of the party, but they tend to have addictive personalities.
You can have an obsession with the future. Tomorrow is always more important than today. People who are too future-oriented have long to-do lists, are always stressed and never have enough time in the day. They are so goal-oriented, that they let the world pass them by, working for that better tomorrow.
Your time personality becomes the lens through which all decisions are made in the present. A highly negative view of the past makes you skeptical of new opportunities. A hedonistic view of the present means you are ready for anything exciting, so long as it happens now. And being excessively future-oriented means that you will only do something if it fits into your longer-term plan. And, even then, it will just be added to your to-do list.
Time is of the Essence
Zimbardo and MagnifyMoney (the website that I co-founded) sponsored a study in six nations with more than 3,000 people. We gave them each a traditional financial literacy test. We tested them for their time personality. And we assessed their financial health.
The results were clear: Just because you're financially literate doesn't mean you'll be financially healthy. A stronger correlation existed between your time personality and your financial health. In other words, being able to do the math doesn't mean you'll make good financial decisions. But your time personality has a big impact on your financial decisions.
People with highly negative views of the past tended to be risk-averse. The good news: They are more likely to avoid financial ruin, because they won't take massive risk. The bad news: Sometimes a diversified portfolio is better than just cash.
People who are highly present-hedonistic have a high risk of being financially sick. If anyone should listen to the advice of Dave Ramsey, it's present hedonists who have trouble controlling themselves. Cut up your credit cards and switch to cash. Say no to new credit offers. Create a savings account that is separate from your bank account so that you can't access the funds as easily. Sign up for 401(k) contributions to come out of your paycheck automatically so that you never see -- or miss -- the funds.
But not everyone needs to follow Ramsey's advice so strictly. Past- and future-oriented people should not feel guilty using credit cards to earn rewards points, for example, because they can control themselves.
People who are are highly future-oriented are exposed to a different type of risk. Because they tend to be career-oriented and always stressed, they don't give themselves enough time to make good decisions. And they really like insurance products. So, if that's your personality, make sure you give yourself time to think about your options and listen to expert advice. Don't just follow the investment tips of other "successful" people. And have a plan for insurance: Don't just respond to it every time it is sold to you.
How Can You Use This Concept?
Find out your time personality. It doesn't take long. And, once you know your time personality, you can better understand where you are most at risk of making bad financial decisions. And, you can try to set up a system that understands your own weaknesses.
So much of the financial advice we see is one-size-fits-all. It shouldn't be. Traditional financial literacy is important. But it is not sufficient.
Your time personality impacts the decisions you make. Understanding the potential weaknesses of your time personality can help you develop a better approach to making financial decisions.
Nick Clements is the co-founder of MagnifyMoney.com, a website that makes it easy to compare and save money on banking products. He spent nearly 15 years in consumer banking, and most recently he ran the largest credit card business in the United Kingdom.
7 Costly Myths About Banking, Credit Cards Debunked
Your 'Time Personality' Is Doing a Number on Your Finances
Yes they can.
The CARD Act did get rid of the most outrageous abuse: they can no longer increase the interest rate on existing balances unless you go 60 days past due.
However, you need to remember that:
Most credit card interest rates are variable and are linked to the prime rate. Your high rate will only go higher when interest rates increase.
Based upon risk, your credit card company can still increase your interest rate on all future purchases. Your existing balances are protected, but future purchases would be at the higher rate. And determining risk is not limited to your behavior on your existing card. If you miss a payment with another lender, that could lead to an increase on all of your credit cards.
After 12 months, they can increase your rate for almost any reason. But the increased rate only applies to future purchases, and they need to give you 45 days notice.
Credit cards are incredibly expensive ways to borrow money. If you use a card, your goal should be to pay off the balance in full every month. Then, the interest rate doesn't matter.
Bottom line: If you do have debt, you should never be paying the purchase APR. Look for a balance transfer, or get a personal loan to cut your interest rate. And take a long hard look at your spending to put more money towards paying off that debt.
No, they are not.
There is a big difference between a 0% balance transfer (where the interest is waived during the promotional period, discussed above) and 0% purchase financing offered at many stores (where the interest is only deferred).
I regularly encourage people to use balance transfers to help them pay off their debt faster. With a balance transfer, interest is switched off or reduced during the promotional period. Once the promotional period is over, interest starts to accrue on a go-forward basis. This can take years off your debt repayment.
But stores offer 0 percent financing at the checkout. With a lot of these programs, interest is charged from the purchase date if you do not pay off the balance in full during the promotional period. So, if you have a 12-month 0 percent offer -– and do not pay off the balance in 12 months -– then in month 13 you will be charged a full 13 months of interest. They retroactively charge interest, and it will be like you never had a 0 percent offer at all.
This is a common practice. Online, Apple (AAPL) does this, via their partnership with Barclaycard (BCS).
Bottom line: I don't like deferred interest deals. Most people do not understand the difference between waived and deferred interest, and this practice feels deceptive. If you take one of these offers, make sure you pay off the balance in full before the promotion expires.
Credit card companies have different rates for different types of transactions. The interest rate charged on a purchase (high) is different from a balance transfer APR (low).
Before the CARD Act, banks would apply your payment to the lowest APR balance first. Imagine you have a $1,000 balance. $500 is at 0 percent (balance transfer), and the other $500 is at 18 percent (purchase). If you make a $100 payment, banks would apply that to the balance transfer. That way, they reduce the balance transfer (at 0 percent) to $400, while protecting the $500 purchase balance (at 18 percent).
The CARD Act changed that. Banks now need to apply payments to the highest interest rate first. But this only applies to payments higher than the minimum due.
If you only pay the minimum due every month, your payment will still likely be applied to the lowest interest rate balance first.
Bottom line: You should never spend and have a balance transfer on the same credit card. Banks can only "trap" balances when you have multiple balance types on one card.
Not exactly true.
The CARD Act has stopped the handout of T-shirts on the steps of the school libraries, but they can still give sign-on bonuses. And they advertise on campus. For example, Citibank (C) has a "Thank You Preferred" card for college students. If you spend $500 in the first three months, you get 2,500 thank you points as a bonus. That is $25 of value.
Bottom line: I actually find this worse. Before, you got a free T-shirt just for signing up. Now, the credit card companies encourage spend on the card for the "free gift."
In the past, banks would charge you a fee if you went over your credit limit. Today, the CARD Act requires banks to receive your consent to charge an over-limit fee. So, in most cases, banks just eliminated those fees -- which is good news (kind of).
You can still go over your credit limit, if the bank approves your transaction. But the full amount by which you've exceeded your limit will be part of your minimum payment come the next bill, which could cause a payment shock.
More importantly, utilization (the percentage of your available credit that you use) is a big factor in your credit score. Your credit score determines the price you pay for credit. So, if you're over-limit on an account, you are considered riskier. That can result in the credit card company increasing your interest rate. And it could also result in other lenders increasing your rates with them. So you do pay, but it's an indirect cost.
Bottom line: We're glad the fee is gone, but you still need to be diligent and try to avoid going over your limit. If you pay your balance in full every month but are frequently bumping up against your credit limit, ask for a credit line increase.
I have heard from so many people that the way to eliminate overdraft fees is to opt out of overdraft protection. But it is impossible to completely opt out of overdraft.
Federal regulation requires consumers to opt into overdraft protection only for debit and ATM transactions.
But, the regulation does not cover checks and electronic transactions (including bill-pay and monthly direct debits, like gym memberships). The banks have all the power. If they approve the transaction, you would be charged an overdraft fee (typically $35 per transaction at banks and $25 at credit unions). If they decline the transaction, then you would be charged an NSF fee (non-sufficient funds), which is usually just as expensive as the overdraft fee.
Bottom line: You can't opt out of all overdraft fees. To avoid them, keep a buffer or find an account, like Ally, that doesn't charge those junk fees.
Not always true.
To be protected, you need to report the fraudulent transaction within 60 days. Otherwise, you give up a lot of your rights.
On ATM/debit cards, the bank can make you responsible for up to $500 of fraud if you report more than two days (but less than 60 days) after the transaction. On a credit card, you would never be liable for more than $50 (and most banks won't even hold you accountable for $50.)
One area where you will almost always lose is when your Personal Identification Number is used. If someone manages to get your PIN and takes money out of your account, then the bank will almost always assume that you authorized the transaction. Make sure you change your PIN often and never write it down.
Bottom line: Avoiding liability it your responsibility. Track your transactions regularly and call as soon as you detect any suspicious activity. And make sure you never share your PIN with anyone, or make it obvious.