I recently read Jonathan Haidt's book, "The Happiness Hypothesis: Finding Modern Truth in Ancient Wisdom." Haidt is a Professor of Psychology at the University of Virginia. In his book, Professor Haidt tackles the curious question of why our behaviour doesn't always match our intentions.
This mismatch is perhaps most obvious during - or just after - the Holiday Season. Despite the best of intentions, diets fail, carefully planned budgets are forgotten and New Years' resolutions often don't even make it to February.
Part of the reason for this lies in how we, as human beings, are hard wired. Our brains are largely unchanged from the way they operated thousands of years ago, when our actions were governed by instinct. Modern man may have developed a layer of rational reasoning overtop of the primitive brain, but the primitive part of us remains just as powerful all the same.
To get a better idea of the influence that this primitive instinct can have over us, Professor Haidt uses the image of a man riding an elephant. The rider thinks he's in charge, and to an objective observer, he is - that is, until he and the elephant have a disagreement about where they want to go. When that happens, the smart money bets on the elephant to win the argument.
In our personal finances, we all struggle with our own personal elephants. The elephant likes immediate gratification, so we overspend, helped along by the twin temptations of easy credit and a dizzying array of consumer products. The elephant also reacts instinctively, so our reason can suddenly find itself playing a back seat whenever fear and greed raise their ugly heads.
Take, for example, what happened to the equity markets in 2008. Even though the rational rider in us knows that stocks do well over the long haul, the threat of short-term loss can send us stampeding out of the market. Our rider knows that the worst thing we can do is sell when stocks go down and wait until the market goes up to buy back in. But our elephant feels more comfortable in a crowd, so we wait until everyone else is buying before we make our move.
That isn't to say that the elephant doesn't serve a vital purpose in our lives. As Professor Haidt notes, your internal elephant is the source of your passion, energy, perseverance and decision making. Without our emotional reactions, it would be impossible to sort through the thousands of competing decisions we have to make every day, often in a fraction of a second.
But when it comes to personal finance, the struggle between rider and elephant can be fiscally fatal. We humans love immediate gratification and luxury. We always have. The only difference is, thanks to credit cards, this is the first time in our evolutionary history that we actually have the ability to give in to our every whim.
Since most of us have limited means, we need some way to help us delay gratification. Just the act of saving, for example, whether it is for your retirement, your children's education or for a rainy day, requires us to sacrifice at least a certain amount of present gratification at the altar of a future goal.
So how do we deal with the elephant hiding in our personal finances? The trick, according to Mr. Haidt, is to train your elephant to work for you, and use its tremendous strength to your advantage.
We've all heard the expression that an elephant never forgets. The same is true for your internal financial pachyderm. Once your elephant gains a habit (good or bad), it doesn't like to let it go.
The first habit you can teach your elephant is to use cash for all your discretionary purchases. If you put the credit cards away and take a few hundred dollars out of your bank account each week, you will likely spend a lot less.
Cash makes buying something more real than simply putting it on a card. Every purchase you make will decrease your stack of bills, and give you immediate feedback to decide whether or not you really want it.
Similarly, to develop a savings habit, arrange for regular deposits to come directly out of your bank account. If your company has a group pension plan or RRSP, have your monthly contributions deducted from your paycheque.
Of course, there's no point in setting up a regular deduction from your pay if you currently spend more than you earn. So take the time to track your spending before you start trying to train your elephant.
After all, your elephant is one big, tough customer. To train it effectively, you need to be very clear about what you want, and what you are willing to do to get it.
If you are serious about getting financially fit, there are a number of great tools to help you in my book, "The Copperjar System" available at www.amazon.ca. On my website, www.copperjarsystem.com, you can also find several spreadsheets that can help you track your spending, calculate your net worth and project your retirement cash flows.
Try a few of them out, and see how it feels to get control of your elephant.
Of course, it never hurts to keep a few peanuts in your pocket, too. Just in case.
Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of "The Copperjar System, Your Blueprint for Financial Fitness" available on Amazon.
All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.