Psychology of money part 1 | Financial goals | Financial Literacy | Khan Academy

Hi everyone! So here, what we're going to do in this video is talk about the psychology of money. I'm going to talk about different types of things that probably all of us have fallen into at one point or another, and just think about why they're happening.

So the first thing you'll often see when thinking about money—actually, it's not really the first thing, but a common thing you'll see—is known as the herd mentality. This is sometimes just looking at other people doing something and figuring out that, well, maybe I should be doing that as well.

That could happen with investments. Let's say a bunch of people are piling into, say, a stock or cryptocurrency. Even if you don't really understand what's going on, you might just say, "Hey, everyone else seems to be doing it, so I'll do it as well." It could also be with personal expenditures; there might be something that you really don't need, but all your friends are doing it, so you're like, "Maybe I should do that as well."

Or maybe you're seeing social media influencers, and you're thinking, "Well, it looks like the cool folks are doing it, so I will do it as well," even though it might not be in your best interest. The problem with following the herd or just doing what everyone else is doing is that you're not really thinking about whether it's good for you. Sometimes it could be, but a lot of times it won't be good for you.

Now, something that could play with that is oftentimes known as the present bias. There are different ways of phrasing it, but that's really the idea that you're not thinking about tomorrow. You're just like, "Hey, it's in the moment. If I don't have this fun right now, if I don't get this thing that I've always wanted right now, life is short; let me just do it."

Sometimes that might be okay, but sometimes you're selling your future self short, or those are resources that you might have needed for something else.

Now, on the other side of the coin, you might have something known as loss aversion. I have to tell you, I'm guilty of this many, many times. Once again, that could happen on both the investment side and it could be on just, you know, things that you're spending your money on.

On the investment side, let's say you want to invest in stocks, or maybe intellectually you say, "Hey, maybe I could invest in stocks and get a certain return." But stocks go up and down, and this is hard-earned money, and I cannot afford to lose it, so you stuff it in your mattress. Well, that might not be the most rational thing to do—at least put it in a bank account or a bond or something to get some interest on it—but that loss aversion might be causing you to do something irrational.

Loss aversion could also happen with personal expenditures. Sometimes you should get something that requires a few more resources, but you're just afraid of losing or afraid of parting ways with something. So it's something to be aware of.

Usually, people who are a little bit more conservative with their money are doing well in the long run, but if that conservatism is keeping you from investing or taking on a little bit of risk, then that might also be a problem.

Now, there's another, I guess, somewhat related effect, sometimes known as the endowment effect. This is that people don't want to part ways with things that they have, or even if they are kind of worthless to them, they put more value on it than other people would. So they end up just withholding it.

A good example of this is if you've ever tried to sell used furniture or had a garage sale. Let's say there's a toy that you loved when you were a child. You remember buying it when you were a kid for $20, and now someone at the garage sale offers you 50 cents for it. You're like, "No, this is beautiful! I kept perfect care of it; this is an amazing toy!"

But the reality is, if you don't sell it for that 50 cents or a dollar or whatever you're willing to get for it, it's just going to be taking up space in your house—or your apartment, or wherever you are. That space is probably worth more on a monthly basis than that thing that's taking up the space.

So that endowment effect of putting too much value on things that you already own and not wanting to part with it can sometimes lead to things like hoarding, and frankly, just making your life not as good. You could probably get some money for it as opposed to nothing.

So I will leave you there. It's very good whenever you're making any type of financial decision to recognize when you're making a financial decision—whether it could be, once again, investments or purchasing something for yourself or for your family. Just think about what psychology is going on here. What is your real motivation for doing it? Are you doing it because everyone else is doing it? Are you doing it—or not doing it—because you're afraid of risk, because you're afraid of a loss?

Are you doing something irrational, where you want to hold on to something just because other people don't value it as much as you might? Think about that, and hopefully you'll make better financial decisions.