The beginning of the New Year always brings with it those inevitable New Year’s resolutions, and if there is one New Year’s resolution worth making this year is to stop procrastinating when it comes to your finances because it is costing you more than you can afford.
Do you know that for every five years that you delay saving for retirement you have to save an extra 5 percent of your salary. If you start at age 25 you only need to save 15% of your salary but that figure rises to 25% by the time you are 35 – how many 35 year olds can afford to save 25% of their salary? A sobering thought.
For medium term savings every year you delay costs you money. If you are saving for your child’s education in ten years’ time with an investment return of 10% a year and you delay that saving by eighteen months you will have to increase your savings by a massive 25%. That means for example the R500 you wanted to put away for your child will have to increase to R625 to have the same lump sum available. Put another way, you have lost out on R15 000 of free growth.
In his book Predictably Irrational, behavioural economist Dan Ariely grabbles with the issue of self-control and procrastination when it comes to saving. As he points out we all start off with good intentions, like a New Year’s resolution to save or pay off debt, yet these are often short-lived.
“We promise to save for retirement, but we spend the money on a vacation. We vow to diet, but we surrender to the allure of the dessert table. We promise to have our cholesterol checked regularly, and then we cancel our appointment,” writes Ariely who explains that procrastination (a Latin word meaning for tomorrow) is driven by our emotions. We make our promises to save money when we are in a cool, rational state. But then our emotion rushes in and takes over when we see a new car, a mountain bike or a pair of shoes we have to have.
Ariel ran an experiment with his students at his university to understand how they responded to deadlines. The students had three papers they needed to submit before the end of the semester. Those who were given intermediate deadlines during the semester for each paper scored significantly better grades than those who were given no intermediate deadlines and could simply hand all three papers in on the last day of the semester. The latter group’s marks suffered no doubt as a result of procrastination as they rushed all three papers in the last few days before the final deadline.
Ariel concludes that “resisting temptation and instilling self-control are general human goals, and repeatedly failing to achieve them is a source of much of our misery”.
He argues that the best way to get people to make the right choices is to have an authoritative “external voice” that gives the orders. This would be for example compulsory retirement funding. Ariely however says this is not always feasible or desirable and a good compromise would be to give people the opportunity to commit up-front to their preferred path of action.
Commit with a debit order
In financial terms this would mean signing a debit order to go into an investment each month with an inflation-linked escalation so that your savings go up with your salary increases.
Self-control can be helped by cutting up your store cards so that you no longer have access to easy credit. Ariely even talks about a practice of putting your credit card in a plastic container filled with water and leaving it in the freezer. If you want to spend it you have to wait for it to thaw (a microwave would damage the chip) and by then your mind would have returned to a “cool” state.
Stick to your budget by putting the money you have budgeted to spend on entertainment or clothes in an envelope – when that envelope is empty, there is no more. This helps you to only access those funds that you allocated during your “cool” state.
This year don’t just make your financial resolutions, put actions in place to make sure you meet them and overcome the emotional response to spending money.