Course Content
How does money work?
To start understanding money, we need to understand how money works. There are concepts like Pay Yourself First, Magic of Compounding, Time Value of Money and Cost Averaging that would help you understand money.
Recommended Reading
List of blogs and books for reading
The Cost of Free Advice
Case studieson the cost of advice.
The Psychology of Money
Read how your mind works when it comes to matters about money
Financial Literacy for School Students
About Lesson

Managing your personal finance is not just about information and knowledge to take those financial decisions. It’s also about understanding our own automated responses that work in the background. These responses are behind a curtain, it’s in our subconscious mind.

Knowledge is no guarantee of good behavior; but ignorance is a virtual guarantee of bad behavior. –Martha Nussbaum

Knowledge & information is just a small part of the solution. To my mind, it is just 10% of the solution. The 90% solution lies with our financial attitude.

Your attitude is greater than your knowledge. Because there are many situations where your knowledge may fail but your attitude can handle that very well. —Anonymous

We all know that a morning walk and exercise is good for health. But to most of us, there’s a psychological barrier in doing simple things like exercising and taking a morning walk. To break that barrier, we need to understand how our mind works.

Let’s take an example of driving a car. All of us think that the person at the wheel drives the car.  Take a deeper look and the driver is just handling the wheel, alert on the brakes and gears and steps on the accelerator when the roads are clear. Beneath the chassis, there’s a complex engine that is doing all the hard work.

Look at it another way. Can you drive a car which has flat or square tyres? Can you drive a car with no engine?

In personal finance, what we do is play the role of the driver. The engine, in personal finance, is our mind.

In this chapter of the book, we’ll try to look at the complex engine that automates our financial decisions. 

The purpose of this chapter of the book is to make you aware of the engine that is firing the cylinders of your money car.  Yes, it’s your mind, dear!

Let’s start with the money story that our mind tells us.

Your Own Money Story

Personal Finance Management is not about setting some rules that everyone can follow. This is because everybody needs and situations are different. For example, two people of the same age and with same income levels would invest differently.

If we dig deeper, we see that everybody has his/her own money story. Let’s start with answering the following:

  • Do you think money is evil?
  • Do you think money is a bad master but a good servant?
  • Do you fear that you will never have enough money?
  • Do you take money for granted?

More questions!

  • What value did your family give to money?
  • Do you think you could do with more money?
  • What’s the money gap between where you are and where you want to be with money and wealth?
  • Which do you think are the most important stories and memories you have about money?

Do you realize that there is no right or wrong answers? The answers depend on your belief system.

So what’s the story that you tell yourself about love, health and money?

If our internal story about love is that “I’m unlovable” then we choose relationships with people who don’t love us. If our story about money is “it’s hard to get” then we’ll always be struggling to get it.

Every person has a mindset related to money. Some of our minds believe in spending freely, while others have a mindset where you are very tight fisted on money. Some can take risks to get good returns on their investments while others feel that it is better to be safe than sorry.

A lot of your attitude towards money is shaped by the families that you were raised in. If you grew up in a home where there was a lot of conflict and fighting about money, then money could become linked at an unconscious level to conflict. Your Money Myth could become “money equals conflict.” And every time you thought about money, you’d feel anxiety – the same feeling you had when your parents fought about money.

Each of us has an underlying story – what you might call a belief system or “guiding fiction” – about each key area of our lives.

We have one story for love, one story for health, one story for success… and, of course, we each have our own personal story about money.

These stories that we have about each of the key areas of our lives were laid down mostly in childhood, before we can even remember.

So here’s the most important question: What is your Money Story?

The Yaksha Story

In Mahabharata, the great Indian epic, there’s a story of a Yaksha asking some intriguing questions to Yudhisthira. The story goes like this:

One day while living in exile in the forest, Yudhisthira finds that while attempting to drink water from a lake, all his brothers have been killed by a mysterious Yaksha (a celestial entity). When Yudhishthira arrives the Yaksha challenges him to answer all his questions or else face the same consequences as his brothers.

One of the questions was “what is the most wonderful/surprising thing in the world?”

Yudhishthira answers that the most amazing thing is that even though every day one sees countless living entities getting old and/or dying but no one can imagine him/herself getting old and/or taking that last journey!

That’s why even though Insurance is an important financial product or financial planning is a useful exercise, people have a natural tendency to avoid it. In fact most of us cite the agents pestering and tax issues for taking insurance!

Psychological Barriers

You cannot change the truth; but knowing the truth can change your life

Let us take a look at some barriers to rational financial decisions. We will cover:

  • Mental Accounting
  • Fear and Greed
  • Loss aversion
  • Decision paralysis
  • Mental decision making process.

Human behavior flows from three main sources: desire, emotions and knowledge. – Plato

Mental Accounting:

Understanding Mental accounting is very useful when want to be able to handle our personal finances effectively. Mental accounting reflects some deep rooted behavioral patterns and it’s very useful and interesting to be able to understand our own behaviors.

Talking to a relative about real estate investments helped me understand mental accounting in a better way. Let me share it with you.

My relatives bought a flat in 1999 for Rs 11 lakhs and they were about to sell it for Rs 30 lakhs. Three times in 10 years is good enough for me, he said.

Fine enough, but I asked him a few more questions.

Did he spend on getting some interiors/woodwork done? Yes it cost him around Rs 2.5 lakhs.

Any maintenance costs? Yes, it added up-to another Rs 1.5 lakhs.

Did he get some rent? No, he did not get a good tenant as he was very choosy.

What we saw was a mental accounting that he got three times in 10 years.

If we get real, the costs added upto Rs 15 lakhs and the money doubled in 11-12 years.

If we actually calculate the CAGR, the return would hover around 6%. (See the rule of 72 in Chapter III)

Each one of us has some automated thoughts about investing in real estate. Most of us think that it is an investment that gives good returns. Would you like to revisit that notion?

It’s up to you to have an open or an unshakable mind!

Fear and Greed

When it comes to our money, fear and greed are the two most critical emotions that affect our decisions.  Even when we don’t know or realize the fear and the greed in our subconscious mind that is taking decisions automatically.

Fear is a natural survival stimulus when in an uncertain, strange situation or when you perceive danger. Money will naturally stimulate the feeling of fear since it is strange as well as dangerous to people who don’t understand money. FEAR is “False Evidence Appearing Real.”

We all know that being afraid of the future is just as silly as being afraid of our own shadows, and yet we fear it all the same.

But Fear is not a sign of weakness. It’s all right to be fearful of money, people, animals until you understand them well.

For example, it’s all right to be fearful of poisonous snakes. But then you see people handling poisonous snakes and once you learn and understand, the fear vanishes.

Greed: The famous 1987 movie, Wall Street, has a line on greed that you must have heard about. It goes like this:

Greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind


But too much of greed and fear is not good for our health as well as wealth. Greed may lead to a desire of having more and more and therefore ruining our balance. For example, greed for sweets or beer can add a pot belly that harms us in the long term! Greed for too much money can lead you to do illegal things.

And being too fearful leads to a paralytic situation where you can die out of panic. For example, there are many deaths from snake bites even when the snakes were not very poisonous.  People can die due to panic.

The effect of Fear and Greed on our investment decisions often trumps more controlled or rational responses.

A study goes on to say that those emotional reactions “short-circuit” more complex decision making faculties. For example, those involved in the management of portfolio of stocks/ securities, the result of emotional reactions is poorer trading performance.


The Takeaway:

Fear and Greed are two natural automatic responses and they cannot be labeled as good or bad.

What’s important is to be aware of the fear and/or the greed that lurks within us. And then keep them in control as we do with our children!

Loss aversion

Here are some questions for you:

  • When it comes to investing, does your primary goal is to minimize the risk of losing money? Even when inflation is eating into any growth that you get?
  • Are you uncomfortable with the volatility of the markets?
  • Your stomach churns when there’s a big market downfall?
  • Do you believe that the stock market is not for you as people have got their investments wiped out?

If you answered yes to the questions above, you have a fear of losing and you have a psychological condition called “Loss Aversion”.

I am not saying that loss aversion is a good or a bad thing to have. In fact, we must be careful not to rush into investments. As they say, “Fools rush in where Angels fear to tread”. But we must make a distinction between avoiding risk and managing risk.

Here are a few pointers that seek your attention:

  • You invest Rs 1.0 lakh in fixed deposits yielding 9%. So after 1 year you get Rs 1.09 lakh. However, the inflation has hovered above 10%. So assuming a 10% inflation, the value of your money is Rs 1.09 lakh x 90% = Rs 98,100/-. So essentially the value of your investment of Rs 1.0 lakh has reduced to Rs 98100/-.
  • Equities have returned 19.67% per annum over a period from 1979 to 2007 while the returns on PPF have been just 10.4% per annum. (Source: Parag Parikh’s Book, Value Investing and Behavioral Finance)
  • While Rs 1.0 lakh invested in stocks in January 2003 has reached a value of Rs 5.24 lakh in January, 2010. The same amount invested (Rs 1.0 lakh) in both KVP and Bank’s deposits reached the value of Rs 1.71 lakh and Rs 1.44 lakh respectively. (Source: NSE)
  • Investments with a long term view in stocks like Infosys, Wipro has turned into big fortunes.
  • Intelligent investors have used the crash of 2008 to buy more stocks that were then available at a low price and have given handsome returns.

The idea is not to avoid risks but to manage them rationally. And also to be aware of our thought process and not let any psychological barriers to interfere with our investments.

Decision paralysis

The term “analysis paralysis” or “paralysis by analysis” refers to over-analyzing (or over-thinking) a situation, so that a decision or action is never taken, in effect paralyzing the outcome. A decision can be treated as over-complicated, with too many detailed options, so that a choice is never made, rather than try something and change if a major problem arises. A person might be seeking the optimal or “perfect” solution upfront, and fear making any decision which could lead to erroneous results, when on the way to a better solution.

The phrase applies to any situation where analysis may be applied to help make a decision. For example if you have to buy a house and you start tracking hundreds of projects, projecting your future income & relocations and compare the advantages and disadvantages of buying versus renting. This detailed analysis can result in a brain freeze. This is often phrased as paralysis by analysis, in contrast to extinct by instinct (making a fatal decision based on hasty judgment or a gut-reaction).

When it comes to financial decisions, there can be many consequences of decision paralysis:

  • You want to buy a house and have one good option available. However you want to look at more options to choose from. Nothing wrong about that, but I have personally met a lot of persons whose range of options do not come to an end. They are still looking at options to choose from, many years later!
  • You do not buy a stock when it was available for a cheaper price. Or don’t sell even when there is a professional advice to sell.
  • With over 8000 stocks, 1000 Mutual Fund schemes, 1000+ insurance policies, 100+ bonds/securities to choose from, we are often paralyzed to take any decision.
  • Research says that as you get more and more information, the decision making process become more and more difficult.

Mental Heuristics (decision making process)

We have our own automated mental processes to reach every conclusion. But it’s not worthwhile to jump to conclusions. Because the conclusions can jump at you too! Let’s find out a bit more about our mental heuristics and biases.

heuristic is a mental shortcut used to solve a particular problem; it is a quick, informal, and intuitive algorithm your brain uses to generate an approximate answer to a reasoning question. For the most part, heuristics are helpful, because they allow us to quickly make sense of a complex environment, but there are times when they fail at making a correct assessment of the world.

When our heuristics fail to produce a correct judgment, it can sometimes result in a cognitive bias, which is the tendency to draw an incorrect conclusion in a certain circumstance based on cognitive factors. For example, people tend to use the availability heuristic to assess the frequency of a class or the probability of an event by the ease with which instances or occurrences can be brought to mind.

The following four statements define heuristic bias (Source :Parag Parikh’s book , Stocks to Riches)

  • People develop general principles as they find out things for themselves.
  • People rely on heuristics to draw inferences from available information.
  • People are susceptible to certain errors because the heuristics they use are imperfect.
  • People actually commit errors in particular situations.


After having understood our own behavioral patterns, we might like to change a few things. Changing behaviour isn’t that simple. No?

Let me share some tools and perspectives on behavioral change.

Guy Kawasaki tried an experiment where he placed two rubbish cans next to each other. One had no cover, so people could throw anything into it. The other had a cover with a six-inch round hole—the perfect size to drop cans and bottles. There were no oral or written requests to segregate and recycle the trash.

The results of the experiment: the trash can with the round hole was filled with bottles and cans. There wasn’t anything other than bottles and cans in it.

This illustrates how you can change behavior if you create paths or flows of the smoothest kind.


Here’s a starter teaser test for you!

Do you have the belief: Change is difficult and takes a long time?”

If you answer yes, you have that belief and any change would really take time!

If you answer No, changing course is just a click of a button! What belief do you choose?

It looks like you can teach behavior when you make it simple. We overcomplicate so many things in the workplace. It also shows that people will do the right thing when you make it easy to do so.

Let’s take one money behaviour example:

If you need to change your investing behaviour, simply automate your SIP. Or mark fixed days on your calendar to buy ETF/ Select stocks. Ordering the bank to simply cut an amount from your account means that you don’t have to think about it every month.

This also means you cut out the emotion out of your investing. And it’s definitely a change for the better!

Top 10 Mistakes in Behavior Change

Stop Your Brain to Take Quick Investment Decisions

That’s what the book, Your Money & Your Brain by Jason Zweig says! Zweig simply points out that making investment decisions is one area where intuition and snap judgments simply don’t work and where our first reaction is usually the wrong one.

Read the review of the book here:

Excerpts: Zweig’s basic premise is that the function of our brains evolved to serve early humans in their quest to survive in a sometimes hostile world. We still react to investment news and make decisions with the same mental firmware that allowed our forebears to avoid getting eaten by large carnivores, and that often leads us to poor investment choices.

Zweig points out the weaknesses of our investing brains, which are programmed to find patterns in the world around us. That may be good for coping with the natural world, but it is less useful for investing. For one, we leap to conclusions. If something happens twice in a row, we automatically project a third occurrence. We do this automatically and unconsciously.

Our “prediction” circuits are driven by the release of dopamine, a powerful brain chemical related to pleasure and rewards. This is one reason why people are drawn to stocks that keep going up; unfortunately, this neural extrapolation is usually setting us up for a fall.


After learning about a few behavioral patterns related to money (Lights) and then knowing more about some tools to change behavior (Camera), it’s time to translate our learnings into some action steps. Answer the following questions:

Question #1: What is your personal “Money Story” about money and wealth – the programming you got when you were young – that affects everything you think and do with money?

Question #2: Imagine that you have all the financial resources to do anything you want to do in life. Now, what is “The Gap” between where you are with money and wealth – and where you’d like to be in the future?

Question #3: What are the behavioral areas where you would like to change? What is your Action Plan taking control of this critical area of your life?

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