3 Cognitive Biases That Make Saving Difficult
Present Bias
Us humans naturally have a tendency of preferring to get things “now” rather than “later”. This helps explain the temptation that leads us to buy that cup of coffee now instead of saving the amount for later use. This bias holds true even if the later reward is greater in amount or significance. In the case of money, this means that we are naturally biased to spend money to get things now, rather than invest it to get something in the future, even if this entails a growth in value resulting in greater value in the future.
Loss Aversion
When saving part of your salary, it makes sense to transfer this amount from your normal bank account (since salary accounts generally have very low interest rates, i.e. your money doesn’t grow in value which is a possibility if you save it in another type of account or invest it). The process of actively withdrawing money from our account, even if it goes to another one that we own, is not very attractive since we are deducting an amount that we can then no longer use to spend. It seems to us like we are losing out on the money we withdraw, maybe it even means that we lose out on a social activity that costs. In this case with a social activity on the line, our innate bias of loss aversion is strengthened because of the added layer of social pressure and need of belonging. The fear of loss is extended beyond aversion to losing money but also to aversion to lose status or social sense of belonging.
Inertia
Inertia is the tendency to not change how things are and retain the status quo. Inertia means that we don’t act, but just stay passive to how things are or how things “happen” to change for us. Inertia contributes to the difficulty experienced when trying to form habits, and if you haven’t done it (successfully) before, to start saving is a new habit.
How to combat these biases with “snudging”
Have you ever heard about nudging? It is a concept sprung from behavioral economics, an area within which the pioneer of nudge theory Richard Thaler won the Nobel Prize for in 2017 [1]. Thaler was a key proponent of the idea that humans do not act entirely rationally, as is assumed in traditional economic models, but that other factors such as emotions and biases play a significant and predictable role in decision-making and human behavior. “Nudging” is the act of utilizing the knowledge of the human psyche to design the “choice architecture” [2] - meaning the environment in which we make decisions and behave - in a way that is beneficial to the goals of the person(s) being nudged. The environment called choice architecture can be physical, mental or social. Biases are natural in the human psyche, helping us to make quicker decisions that often lead us right. However, the cases where this is not true can have minor or major negative effects. This is why sometimes nudges are used to leverage the biases that we have in order to generate a better outcome. Within the field of nudging, nudging yourself is given the comical term “snudging”, referring to “self-nudging”. Here are some “snudging” tips to help yourself be better at saving:
Set defaults
One very useful nudge, or “snudge”, is a default. Inertia favors defaults, so setting defaults is a way to leverage this bias. An easy but powerful example of setting a default is to put away money to save each month by setting up an automatic transfer from your salary account. This way, your tendency of inertia will not be an obstacle to your saving goals since you will save by default. A good app for this is Dreams, who have features harnessing the power of defaults, and helps you save.
Increase the salience of the consequences
A synonym for salience is prominence, and to make something more salient means making it more noticeable. You probably heard that we have an easier time remembering things that we connect to emotionally, and this is because emotions make the memory stand out and be more noticeable amongst others. Thus, a way to get better at saving is to increase the salience of the consequences of not doing so. You could either focus on negative or positive consequences, but the former is probably more effective since our brains are, sadly, wired to relate a higher emotional response to negative consequences (this is because our brain’s lag in updates since our life on the savannah, where the damage of accidentally thinking their is a tiger in the bush when there isn’t is better that thinking that their isn’t when there is one). So, basically, scaring yourself by thinking of what happens if, for example, you are the victim of an accident in a year, your insurance does not cover the damages and you haven’t saved enough money to cover them by yourself either. Maybe you have to sell your tv, car or - knock on wood - your pet. A way to further increase the salience of the consequences of not saving is intertwined with the following saving “snudge”.
Commit to a friend (use of social norms)
You can ask a friend to hold you accountable to saving. An example of this picking up where the previous “snudge” left off is to give a friend a certain amount of money beforehand that they can, if you fall of the wagon and fail to save, do something with or donate to an organization or political party that you fundamentally don’t agree with. Another way of using social norms is to commit to sending your friend a screenshot of what you save (or just that you have made a transfer to save) each month. Finally, in a way to use social norms and also combatt the bias of loss aversion, you can ask a friend to join forces with you and plan to do something fun for a part of the money that you manage to save together.
Increase the transparency of your spending
Creating a budget is always a smart idea. Keeping track of it is even smarter. There is nothing wrong with doing it in excel or in a notebook but today, there are many apps out there that help you do this in a really simple way. Two good examples are Tink and Wally. “Sunlight is the best disinfectant” is a saying uttered many years ago by justice Louis Brandeis in the American Supreme court [3], and used by Thaler and his colleague nudging pioneer Cass Sunstein to describe how effective disclosure and transparency can be as a nudge. Highlighting the facts of how something really is and showing it to the person or people concerned, is a tool for generating a desired change. That is why inertia also often tends to make us want to put on our blinders and hide from the facts, because it is more comfortable. By making it visible for yourself how much you actually spend on buying gum, coffee or eating out, it might urge your motivation to make more deliberate decisions. Maybe it becomes clear how saving up to keep your pet in the future means more to you than gum or the tenth weekly cup of coffee.
[1] https://www.nobelprize.org/prizes/economic-sciences/2017/advanced-information/
[2] Thaler, R. H., & Sunstein, C. R. (2008). Nudge: Improving decisions about health, wealth, and happiness.
[3] https://en.wiktionary.org/wiki/sunlight_is_the_best_disinfectant
Photo credit thumbnail picture:
Thanks to Micheile Henderson! (@micheile on Unsplash.com)