Last week, I decided to help my son with his physics lessons. While doing so, my mind kind of drifted towards the connection between physics and finance. Albert Einstein once mentioned that the power of compounding is one of the greatest forces in the universe. Indeed, and it also applies to the basic principles of personal finance and money.
Newton’s laws of motion, which form the foundation of classical mechanics, can also be used to explain decision-making in personal finance from a behavioural perspective — here’s how:
Newton’s First Law
The rule of inertia…a body will continue to be in its present state of rest (or motion) unless acted on by an unbalanced external force. Simply put, a person will continue to do the same thing over and over again until an external force comes into play to change the habit. Traditionally, a retail customer repeats the same mistake until they are hit upon by a life-changing event. Sadly, the event could be so debilitating that it would take another life time to recover from it. Hence, it is important for us to move out of inertia and take steps to better our financial life.
Newton’s Second Law
The second law explains how the velocity of an object changes when it is subjected to an external force. The law says force is equal to change in momentum (mass x rate of change in velocity) per change in time. Momentum has both direction and magnitude. Thus, if an unbalanced force (wrong financial decisions) is applied on an object (us), it changes the velocity of the object and in turn its momentum. Financial decisions are an important ‘unbalanced force’. When a wrong decision is made and worse, continued to be made, it gains momentum with time and takes us in the wrong direction. As per the law, if a body is subjected to multiple forces at the same time, then the acceleration produced is proportional to the vector sum (the net force) of all the individual forces. Thus, multiple wrong decisions will only add to the momentum and hurtle us down the hill. It is important to get the right advice and execute the same to reap the benefits of momentum and magnitude.
Newton’s Third Law
The most famous Newton’s law—for every action there is an equal and opposite reaction—indicates that when one object exerts a force on another object, the latter instantaneously exerts a force back on the former. These two forces are always equal in magnitude, but opposite in direction. In our lives too, there is always a temptation to live beyond one’s means. One has to make hard financial decisions such as cutting down on splurging or a party or a holiday. Our first reaction is to push back with equal force, but in opposite directions. These push backs will actually hurt us in the long run.
Many a times, we are told some harsh truths about our financial life which we tend to push back. It is always advisable to digest these realities and take some firm decisions to make our life better and safer.
Nitin Vyakaranam is founder and chief executive officer, ArthaYantra Corp. Pvt. Ltd.