31st May 2016 at 10:26am
There are lots of things we all know we should do – saving is one of them. But why do we find saving so hard?
We should keep healthy, eat five a day and go to the gym. And we know we’d be better off and feel more secure if we made the most of our finances; perhaps by changing to a cheaper utility provider, switching bank accounts to get a better deal and sorting out our pensions.
We could put a little extra away to build up our savings in our workplace pension with its tax relief and employer matching, along with the potential of better long-term investment returns.
Yet few of us do, even though we’d stand to benefit. We reach for the cakes over the fruit, and leave our finances for another day.
The question is, why? And if this sounds like you, is there anything you can do about it?
Three reasons we find saving hard
The theory is that when it comes to money and savings – among other things – our reluctance to do things we’d benefit from is more often than not driven by three reasons, rooted in psychology.
1. Inertia: Many of us find it hard to get round to doing things, especially when they seem hard to do. It’s much easier to do nothing, even if we risk losing out.
So we stick with expensive insurance, don’t shop around for the best deals and never quite get round to saving.
2. Present bias: This is the habit of valuing immediate rewards over our long-term intentions, particularly where these “cost” us in some way. It can have big implications, particularly later in life.
Making New Year resolutions is a good example. We promise to give up bad habits, ditch the credit card, or top up our pension contributions… soon. As for healthy eating, we might start it after eating that last bit of cake.
3. Loss aversion: People worry more about the ‘loss’ of giving something up than the gains they might get.
And it’s not just something that affects people. US behavioural scientist Shlomo Benartzi talks about a study of monkeys and apples.
One group of monkeys is given an apple and they’re pretty happy. Another group gets two apples but one is taken away. And guess what? They’re not very happy at all – in fact they’re pretty angry. Yet they still have an apple left. They’re in exactly the same place as the first group. But they’re not happy because the loss weighs heavier on them.
What’s the solution?
Understanding that all this is pretty natural for many people can be helpful but changing behaviours can be hard. Given that’s the case, what can you do about it?
Well, here are three ideas, again rooted in behavioural psychology.
1. Substitution: Rather than try and stop something altogether, it’s often easier to swap it for something similar. The classic example of this is switching from cigarettes to e-cigarettes, rather than stopping smoking altogether.
2. Small steps: Instead of attempting to change something big, start small and easy. This helps overcome inertia and loss aversion. So, if you know you need to save more, don’t start by trying to figuring out your entire finances. Instead, increase your savings by something small, say £50 a month. Taking a small step is better than never getting round to taking a big step.
3. Make a commitment: We’re more likely to achieve a goal if we commit to it with friends or family, much like joining a gym for example. And this effect is stronger if we agree a penalty in advance if we don’t do it – that way we’re making loss aversion work for us. Collecting sponsorship to run a marathon is a great example of this, particularly if you feel you’d need to pay the sponsorship money yourself if you didn’t make it round the course.
Three behavioural barriers and three solutions; it all sounds simple enough, but as we know changing deeply-grained behaviours can be easier said than done.
However, no-one ever succeeded at something simply because they hoped they would. You have to do something about it, which requires tough decision making and sometimes a bit of grit.
Just remember, not making a decision is a decision and if you’re going to make a decision then why not make a positive one?”
The information in this blog or any response to comments should not be regarded as financial advice and is based on our understanding in May 2016.