Updated on 08.27.14

Fuzzy-Trace Theory and Your Money?

Trent Hamm

How False Memory Impacts Your Financial Decision Making

Fuzzy-trace theory?

Fuzzy-trace theory is just an odd-sounding name for a pretty simple idea – the idea of false memory. To put it simply, the idea is that people form two different types of memories, and it has big implications for your financial decision making.

Explaining Fuzzy-Trace Theory

One type of memory, called “verbatim,” is just like it sounds – it’s a very detailed and accurate representation of something experienced or learned in the past. For example, I can still perfectly recall several poems that I memorized decades ago.

On the other hand, we also have “gist” memories. These are memories that are heavily based on context. We don’t remember these things verbatim – instead, we tend to build these “memories” out of small pieces of memory and knowledge.

Almost everyone has both of these memory types, but different people tend to be stronger at different types. Both types can create false memories in different ways. I know, from my own experiences, that I have a very good “gist” memory, as I can often reassemble past events or ideas pretty accurately even though I might not have a verbatim memory of that event or idea (though, sometimes, I botch this pretty badly). My “verbatim” memory, on the other hand, is usually pretty poor for larger ideas. My mind works best remembering lots of little things and knowing how to reassemble them pretty quickly, in other words, and those reassemblies are usually quite accurate.

Anyway, one fascinating part of this idea is that the more things you’re trying to remember, the more likely you are to rely on “gist” memory. Remember, “gist” memory is less accurate than “verbatim” memory.

False Memory and Financial Decision Making

So, how is this important? Let’s say you have one credit card in your wallet. It’s likely that you’re able to know the exact balance of that card – or pretty close to it. That one point of data is likely lodged as a “verbatim” memory in your head.

On the other hand, let’s say you have ten cards in your wallet. That means, in order to have a good grasp on the balance of each one, you need to have ten “verbatim” memories in your head. More likely, you’re going to be relying on “gist” memory – a sense of the spending you’ve put recently on each card rather than an actual balance for each one.

“Gist” memory will get you in trouble. If you don’t happen to recall some spending on some of your cards, you’re going to underestimate balances. This will often give people a sense that they can spend when they shouldn’t, and then when the statement comes in, they’re facing a nasty shock.

This isn’t just about credit cards, either. Relying on your memory or “sense” of your buying habits or your other personal finance choices is a sure route to making mistakes.

Minimizing False Memory

Thankfully, there are a few steps you can always take to reduce your mistakes.

Minimize your active credit cards.

You shouldn’t carry a balance that varies on more than one card – two at the most. The more cards on which you carry a balance, the harder it will be to remember all the balances and the easier it will be to see your spending slowly snowball out of control.

Rely on hard numbers – not your memories – when making financial decisions.

Don’t just base things on what you think. Base things on the facts. Look up your balances and your account data before making financial choices. Don’t allow yourself to rely on memory at all.

Rely on a “spending allowance” to keep your non-essential spending in check.

Again, don’t rely on your memory to tell you whether or not you can actually spend. If you make a lot of little spending choices over the course of a month, you’re likely relying on “gist” memory to get a sense as to whether you can afford to spend more, and that’s unreliable. You’re far better off giving yourself a strict allowance and focusing solely on how much you have left in that allowance.

Don’t let your memory be the basis of your spending decisions. Instead, rely as much on the facts in front of you as you possibly can – and when you can’t, plan ahead to protect yourself against poor decisions.

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