29th June 2016 at 10:20am
What is it that makes some people better at making financial decisions? And is there something we can learn from them so that we don’t miss out?
After all, most of us want to make the very most of our money. It helps us enjoy life, gives us peace of mind and choices.
Could making good financial decisions be down to… speed?
Nobel prize-winning behavioural scientist Daniel Kahneman believes it certainly plays a part.
Kahneman, who is well known for his work on the psychology of judgement and decision-making, argues people think in two ways; slow and fast.
Slow is when you have to work at it, weigh up the pros and cons and take time to think about the things which are most important. Buying a car or house are good examples. You need to get it right or there are significant downsides. These aren’t decisions you make very often.
But brains are hard-wired to think fast and make quick, intuitive decisions. Should you buy a certain type of milk or take the stairs as opposed to a lift? Clearly, they’re not as important, but they are easy.
It’s just so much easier to think quickly. We can’t spend time pondering everything. And if something is complex and we’re forced to think slow, inertia tends to result and we end up making no decision at all.
Decisions matter… and money decisions matter a lot
When it comes to your finances the stakes are higher. Taking the time to think hard and make the right choices can be the difference between doing okay, and doing a lot better. But it takes a bit more effort.
It’s particularly true if you have more than the average person has to save or invest.
Your pension is a clear example. Many workplace schemes match part of your contribution, so if you pay in 4 per cent, for example, the company pays 4 per cent too.
It’s a great deal for sure. But it can be hard to work out exactly how much you should contribute so many people just stick with the basic 4 per cent – this becomes an implicit default option.
It’s easier and you don’t need to think, or do, anything. Perhaps 4 per cent will ‘do’.
Why miss out on the tax-efficient benefits?
And yet for higher rate taxpayers, saving into a pension is one of the most tax-efficient things you can do.
You get tax relief of 40 per cent on what you pay in as a higher rate taxpayer. The result is you can save more, and have a better chance of building enough savings to last you. And you save on tax.
So, choosing to pay more than the basic amount, the implicit default, makes a lot of sense. And that’s before you even factor in anything your employer contributes.
Making good money decisions
And that’s just one example of many that come to mind. Another is where a company offers its employees the opportunity to buy shares and matches them.
You know it exists but you’re either not sure how it really works or haven’t joined it, yet. (And will you, really?)
It amazes me that more people don’t take the time to look into it, or don’t make the most of it. As well as free matching shares, you pay for the shares from pre-tax salary. You could say they effectively become tax-free pay in the form of shares.
And the icing on the cake is that if you hold them for at least three years you can sell them tax free too.
It’s actually easy to do, if you just take a bit of time.
Obviously there are risks and caveats. If you have company shares, as with any investment, these can go down as well as up in value. There may also be specific conditions attached to the buying and selling of them.
So what’s the lesson? Go slow…
Well-ordered decisions may take that bit more effort but if you think consciously, you are the one who could stand to benefit.
Take the time to make the most of your finances, including your pension. And that includes making the most of the tax breaks open to you. I’m with Daniel Kahneman on this.
The views expressed here are those of Andy Dunbar and should not be regarded as financial advice.
If you want more in-depth guidance on any of this, speak to your adviser if you have one, or find out more about your workplace pension scheme from your employer.
Laws and tax rules may change in the future. Your personal circumstances also have an impact on tax treatment. As with any investment, the value of a pension can go up or down and may be worth less than what was paid in.
This information is based on our understanding in June 2016.