You are one of the world’s great magicians and you probably don’t realize it. Magicians deal with illusions, misdirecting from what is going on through mental games. But you, too, create illusions. And ironically, you are both the magician and its audience. The sleight of hand is your own, yet you are still fooling yourself.
According to a paper in the Journal of Marketing Research, “The Illusion of Wealth and Its Reversal,” by Daniel Goldstein, Hal Hershfield, and Solomon Benartzi, we create an illusion of wealth or its reversal because we view lump sums differently from monthly payments.
Have you leased a car because the payment was so manageable? Or do you have money sitting in a savings account while you are paying credit charges? This is the financial equivalent of sawing a woman in half.
One of our wealth client couples was never able to connect to the amount of money that they had when we went over their balance sheet of what they owned and what they owed. It was only after we were able to show them the expected income stream those assets would produce that they began to get comfortable with their security.
They had tricked themselves into feeling poor even though they weren’t. This illusion of poverty caused them great conflict because they didn’t believe they could afford to spend money that they clearly had.
But maybe you are the opposite. You think that your financial life is fine because you are not behind on your rent, car payment, credit cards, school loans and other ongoing costs. Somehow, each month you pull a rabbit out of your hat and barely stay ahead. You may have fooled yourself into believing that you are better off than you are through the illusion of wealth. This magical thinking leads to saving less than you should because you have a difficult time relating to lump sums such as a 401(k) balance.
Magicians don’t reveal their secrets because once we know what we are looking for it is more difficult to be fooled. It is now time to let you in on how to overcome these illusions.
When you are looking at refinancing your home, if you roll all of those extra costs into the mortgage because it only adds a few dollars a month, you fell for the great housing shell game. A couple of thousand dollars up front is far more painful than a few bucks each month, yet those additional costs continue to compound over the life of the mortgage. When you are refinancing, if your payment goes down but the amount you owe goes up, look at how long it will take you to pay off those additional costs. This is especially important if you plan on selling the home in a few years. You may be better considering a zero-cost mortgage at a slightly higher interest rate.
When you are buying an annuity that gives you a guaranteed minimum return combined with a stock market return, you have been fooled by the coin in the hand game. Why? Because safety and risk are oil and water. Those guarantees have to result in a cost. Most don’t realize that the cost comes in two ways: a limiting of the growth on the stock market side and a limiting of flexibility on the withdrawal side. In order to receive the guarantee, you need to annuitize, meaning that your lump sum has become an income stream. That may be exactly what you want, but there are other ways of employing that strategy that could be less costly. You may have thought you were watching where your coins went, but they inevitably got pulled from your ear.
What about when you save so aggressively each month that you are unable to enjoy your life today? Ah, that never ending scarf that you plan on pulling out in retirement will be a noose for you. The best savers are often the worst spenders because the very reason that they were saving — generally the fear of not having security — doesn’t go away because of the illusion of poverty. The best magicians use uncanny discipline through years of working on their tricks. Developing an appropriate balance between living for today and living for tomorrow is important practice to help you create the skills to overcome that unhelpful illusion of poverty.
What if you are coupled, and your spouse and you operate from different illusions? What usually happens, is that the concerns become more exaggerated over time because the tricks are so different from each other. It doesn’t help to downplay your partner’s responses because when couples don’t communicate they tend to get more entrenched. The tool that we have found that works the best is the old reversal card trick. Have each partner describe in positive terms how they view their partner’s money approach. If the saver can describe some of the enjoyment they have received from the experiences that the spender has created and the spender can see how much flexibility has been created by the saver, there is a chance that they can become more aligned.
While it can be fun to lose yourself in a magic trick, don’t do it by fooling yourself.
Ross Levin is the chief executive and founder of Accredited Investors Wealth Management in Edina.