We know if we want to lose weight we need to eat less and exercise more and we know that in order to grow wealth we must spend less and save more. So why then do we give in and buy the chocolate bar at the counter when we purchase our groceries, or whip out our credit card for the latest smart TV or purchase a car with massive monthly repayments, derailing our financial plan?
Many economists and psychologists have made careers out of trying to understand why we make “bad” choices which we invariably regret.
What they have concluded is that we suffer from what is called “present bias” – we place more value on the present than the future, so our present happiness or gratification is more important psychologically than future happiness.
In one experiment, a group of people were told that they were going to have a meeting in a week’s time and could select a healthy snack such as a banana or an unhealthy snack such as a chocolate. Nearly three-quarters of the group asked for the healthy option. On the day of the meeting, however, they were told that there were enough bananas and chocolates, so they could choose either. Almost everyone took the chocolate.
What this tells us is that we are better at making healthy decisions the further away we are from the actual event, but once we come to realising the actual decision, then our “present bias” kicks in. That is why so many of our financial resolutions collapse by the end of January.
Opting out rather then opting in
We are also lazy about taking action. How many good intentions about opening a savings account fell apart once it came to actually having to fill in the paperwork? Behavioural scientists have found that the best way to modify behaviour is to make people opt out rather than opting in.
This idea was implemented in Austria for organ donation: citizens are automatically signed up as organ donors when they receive their driver’s license, and they then have to actively opt out. As a result, 99% of Austrians are organ donors compared to only 12% of Germans – a nation with a similar cultural background but where one has select to be an organ donor.
So how do you use human nature to your advantage? In the case of the people attending the meeting, if their decision was irreversible they may have felt a bit disappointed when they were handed the banana on the day, but the longer-term benefits on their blood sugar levels and waistlines would have outlasted that moment of disappointment. The organ donation principle could just as easily be applied to receiving your pension when changing jobs – if it’s difficult to cash it in, you’d be more likely not to do so.
What we need to do is to commit to something in the future when our resolve is high and make sure we cannot change that decision too easily once present bias kicks in:
- Cut up your store cards – the hassle factor of applying for another one will make you think twice.
- If you want to have paid off a loan by the end of the year, calculate how much you need to pay in each month and set up a stop order which goes off the day your salary hits your account – you cannot spend money you don’t have.
- Ask your HR department to increase your pension contribution by an additional 2% with each salary increase – you will still have extra money from the salary increase but a portion of the increase is boosting your retirement savings.
- Include an automatic annual 10% escalation on any savings plan.
- If you go “window” shopping make sure you leave your cards at home – most of us are not able to resist the temptation to buy.
- Put a file together with all your FICA documents (copy of ID, utility bill, bank statement) so that the paperwork is handy when you want to open a savings account.
This article first appeared in City Press