Interesting WSJ article that has a behavioral finance bent to it. Before I give you the answer, write down your own response to this question. Your choice will explain a lot about how you think about money. First, the reasons those two choices were given was no accident. According to the article, the $1 million lump sum and $5,000 monthly payment are roughly equivalent when it comes to annuity pricing.  So what does your choice tell you?

• Choose $1 million and you suffer from an “illusion of wealth.” What is that?

“Some people feel that $1 million is a much more adequate amount than $5,000 a month. These people tend to suffer from the illusion of wealth. Because they get a false sense of security from seemingly large monetary amounts, such as those that appear when they check their accounts, they behave as if the $1 million is more than $5,000 in monthly income. This can lead some people to undersave for retirement. One million dollars might seem like a lot—especially if you’re viewing all of those zeros on a small smartphone screen—but it isn’t nearly enough for those expecting to have, say, $8,000 a month to spend over a 20- to 30-year retirement.”

• Choose $5,000 a month and you suffer from an “illusion of poverty.” Huh?

“Because they might be inclined to think about wealth in terms of monthly income as opposed to a large sum, they incorrectly assume that the $1 million they see on the screen equates to less than $5,000 a month. Instead of living the lifestyle they can afford, they worry they’re running out of money and act accordingly, skipping trips and scrimping on prescriptions.”

So, are we damned if we do and damned if we don’t? Well, there is an easy fix…

“There is an easy fix for these two illusions. Instead of highlighting only total wealth, financial websites and apps should help people focus on their projected monthly income, too. It’s this amount, after all, that puts our wealth in perspective, helping us understand the meaning of these large monetary amounts.”

I think this concept also can be applied to a more pressing issue for your students: student loans. Just as the easy fix for this example is to examine both the lump sum AND the monthly payment, the same is true for student debt. Ask students if they would choose $30,000 in student debt or a $300/monthly payment for 10 years and see what they say. I’m guessing most would select the monthly payment since it does seem manageable (teens don’t have a clear concept of time and don’t necessarily know how it feels to making payments for 10 years). Highlight just the principal amount and $30,000 in student loans may seem intimidating. Look at it as a $300 monthly payment for 10 years, and it might seem more manageable. Of course, you also need to look at this figure in the context of an expected salary too. We have an activity for that!

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Here’s the activity that I promised: Calculate: How Much Should I Borrow For College? 

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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