smart spending

7 psychological money traps and how to avoid them

However, this practice can also get you into trouble if you always separate your money into discrete buckets, says Tom Nowak, Certified Financial Planner of Quantum Financial Planning in Grayslake, Ill. For example, "Maintaining a credit card balance (Bucket No. 1) over a period of time even though you have more than enough liquid assets (Bucket No. 2: non-retirement money market funds, savings accounts) to pay off the balances," says Nowak. "Even auto loans or home equity loans with relatively high interest rates can sometimes be paid off with surplus cash reserves."

How to outsmart your brain: Remind yourself that "money is money" -- no matter where it comes from or what category you've placed it in. Don't spend your tax refund on something you wouldn't buy with your monthly salary just because you think of it as "free" money. If you get a $25 gift card from your grocery store for switching your prescription to their pharmacy, don't automatically use the card for something frivolous. Buy the same items you would have purchased if the $25 had been cash from your own wallet.

6. The 'sacred-fund' slip-up 

This one also falls into the category of "mental accounting." Say you receive $3,000 from your beloved grandmother, who scrimped and saved a few dollars at a time to accumulate that money. It's your money now, and generally you're a fairly aggressive investor.

Are you willing to invest "Grandma's money" in the stock market along with your other retirement funds, knowing you could lose some of it during a down year? Studies show that many folks would be uncomfortable risking Grandma's hard-earned money so they treat inheritances much more conservatively than their other cash. The same is often true of our workplace retirement money. We mentally consider it "precious retirement money" that we're afraid to lose, so we put it in more conservative accounts than we really should.

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How to outsmart your brain: Deposit gift money into the same account as your other savings and let it sit, commingled with your other funds, until it no longer feels separate from your other money. Over time, you'll begin to treat it as you would your own earned money. As for retirement accounts, Romzy likes to encourage cautious clients to consider putting just a portion of their retirement funds into investments just a little riskier than usual. This should be true, he says, especially in cases in which you get a match from your employer, in which case you've already earned a 100 percent return on your money just with the match.

"I might suggest they buy a bond fund, a U.S. stock fund, a commodity fund, a real estate fund and an international stock fund. They'll eventually see that their 'riskier' investments begin to outperform their safe conservative ones, he says. That's often enough to break the "sacred money" hold.

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