The psychology of money

What is money? When you need some, you don’t bother with a philosophical question like this. You just try make a sale, lobby for a raise, or get a loan. But to understand finance, and truly understand how people and finance interrelate, you need to think about how people perceive money.

Money can represent status and prestige, success or failure, life or death, convenience or inconvenience. Money has virtually no value of itself. It’s just paper, nickel and copper, or electronic traces in a database. But to the economist, money is capital, that wondrous, powerful stuff of which businesses are built and economic cycles created. And in corporate finance, money is valuable because it provides the capital with which to nurture a business and give it the strength to generate enough excess money to pay the workers and owners some return on their capital.

Listen to how one eminent economist talks about money and capital. I find this quote surprising and exciting since it offers a perception of money so different from ordinary views:

                Capital is powerful on insofar as it continually runs the gauntlet of circulation, each capitalist of necessity distributing his money into the hands of the public (his workers, his suppliers), in order to procure the labor services and materials from which his capital will be reconstituted as a commodity. Each capitalist must win back from the public at large the money capital he has disbursed to various sections of it, and each capitalist is simultaneously trying to win for himself as much as possible of the money capital of other capitalists.  – Robert Heilbroner, The nature and logic of capitalism

Wow. To an economist, then, money is of hardly any consequence at all. It is simply one form capital can take, a form that comes in handy when playing the bole and dangerous game of capitalism. Instead of locking up your capital safely, you must risk it by “running the gauntlet” of business activity – buying and selling, competing with others in the hope that more capital will come back to you than what you put at risk in the economic system. Now that’s an interesting view of money. 

Why is it important how people perceive money? What does one’s view of it have to do with corporate finance, or success in business and life for that matter? 

One’s attitude toward money has a powerful effect over one’s behavior in business and in life. A healthy, realistic attitude toward money, one that views it as a means to an end and treats it with respect, not adulation or lust, is important in life and in work. People who don’t get the psychology of finance right will never master the practice, now matter how sophisticated their understanding. For them, that “gauntlet” of financial risks will always be too much. Somehow, money will slip through their fingers and not return when they need it.

But people who have the psychology of money right are quite the opposite. There are lots of successful entrepreneurs who say something to the effect that, “I just don’t know why, but somehow money always comes to me when I need it.” Well, it’s not really that simple of course. You don’t see these folks sitting on their porches, sipping a cold drink and waiting for a truck to come up and dump money on their walk. They are active, even aggressive, in their pursuit of capital and their use of it. But on the other hand, they do seem to have a healthy knack for generating funds. Deals work out in their favor. They seem to be able to get the funding they need for their ideas. And their businesses always make a healthy margin of profit. 

How is your financial judgment? 

Good financial management is essential to the survival and success of any business. I guess that’s obvious. Yet it’s amazing how often you see businesses and individuals exhibit really poor financial judgment. In fact, many people seem to change personalities when they are exposed to money. To prepare yourself fully for business or personal success, you need to acquire a healthy attitude toward money. And you need to learn to spot unhealthy attitudes in other so as to avoid giving them any access to important funds. 

How good is their financial judgment?

One of the thing I always look for when evaluating a potential business partner or key employee is whether they are “funny about money.” I’ve known plenty of bright, personable people who seem to be perfect for the job, until they gain some control over the funds. Then a darker side of their personality asserts itself!

Money induces financial intoxication, and you often see people lose their inhibitions, their common sense, or their ethics when exposed to money in quantity. In particular, here are some of the most common forms of dysfunctional financial behavior to watch out for in yourself and others:

• ·         Wishful thinking. Lot’s of people believe that somehow they will “think and grow rich” or that if they just wish hard enough money will find it’s way to them. In fact, there are lots of inspirational speakers and trainers who give people advice on the order of, “Write yourself a note saying, ‘I’m going to have a million dollars by the end of the year.’ Put it in your wallet and carry it with you everywhere. By the end of the year, you should be a millionaire.” I figure people who charge good money for advice like that don’t plan to be in town at the end of the year. In business, that sort of “faith financing” is pretty dangerous. There are too many cases in which somebody spends more than they’ve got in the blind hope that somehow the money will come back to them in time to make up the difference. It never does. You don’t want someone who takes a superstitious or wishful approach handling any of your money. And you certainly can’t afford to be that flaky yourself.

• ·         Uncontrolled spending. Some people get overly excited and go on a spending spree whenever they have access to funds. They run up their credit cards and they blow through their budgets. If they can get bank loans, they spend them without regard to how they’ll pay the debt. Expenses must always be tightly linked with revenues. Unless you keep an eye on where the return is coming from, money simply won’t return. So don’t trust uncontrolled spenders – be one yourself.

• ·         Pocketing. A surprising number of people feel a strong urge to put other people’s money in their own pockets. I can’t even count the number of times I’ve been approached by someone for advice about how to handle a business partner who seems to be overly possessive about the partnership’s funds. The scenario usually goes like this. Both (or all) partners have individual signing power on the company’s bank accounts, and they take turns handling financial matters as needed. Everything goes fine, though on occasion the books don’t quite balance as accurately as you’d like. Then one of the partners decides to track down some minor sum that’s gone missing, and in doing so, discovers a long pattern of unaccounted for withdrawls by another partner. Confronted, that sticky fingered partner treats his (or her) behavior as inconsequential. “Oh, sometimes I take out a little cash when I need it, but of course I’ll repay it later. Don’t you, too?” But in truth, little or none of that borrowed money ever returns to the business. And the other partner views it, quite rightly, as stealing rather than borrowing. There are also lots of employees who think nothing of “borrowing” supplies, equipment, or cash if they can get at it, and rarely bring anything back.