Lesson type: Think like an investor

Making the most of money psychology

Ever thought that you’d be ‘better’ at things one day, such as being savvier with your saving, leading a healthier lifestyle, getting more organised across your household or achieving a work-life balance?

You’re not alone. Many of us feel we will simply be ‘better’ selves in the future. Psychologists call this our ‘optimism bias’, and studies[1] show that many of us have this mindset.  The ‘optimism bias’ leads us to believe that even without committing to, let alone actually starting to, make any behavioural changes, we’ll improve our lives across the board.

But in reality, it isn’t that easy.

We’ve all embarked on a savings plan at some point in time. Whether it was for that awesome Lego set or video game in our youth, or for something more significant like a car to relish the freedom a licence provides. All these goals had a relatively short incubation period, and the pleasure of that materialistic item outweighed the pain of saving for it.

These days, saving for retirement or a ‘cash buffer’ just isn’t enticing. We can’t experience the retirement lifestyle right now, so we don’t equate a higher level of excitement towards it to maintain a savings discipline. It’s interesting to note that studies show that people are more disciplined in paying off their debt than they are in replenishing their savings after an expense is facilitated by funds from their dedicated savings pool[2].

As an adviser, I’ve met many people who have the desire to save. They feel they should be able to curb their spending by a certain amount each month but find it difficult to cut back on the lifestyle they’ve become accustomed to.

It’s similar to when we undertake a radical change to our exercise habits. In the beginning we love the increased time at the gym and scaling back on the calories  However over time, we get tired of the early starts or the decrease in social activities the gym regime demands and end up drowning our sorrows in a burger and chips – completely undoing all the hard work we’ve put in!

This can happen with our spending habits too - we’re so good for so long that surely we deserve a splurge!

So, what’s the answer?

Let’s tap into the optimism bias, and avoid trying to curb your spending right now. You may not even need to reduce it. Make an agreement with yourself that when your pay review takes place this year to save at least half of it. So if you receive a 3% increase, commit to saving at least 1.5% of it.

You won’t miss what you haven’t ‘received’ in your pocket, but you’ll still get the reward of more in your account on a monthly basis. The 1.5% could be funnelled into an account you can’t touch, or simply directed to your mortgage or superannuation.

Whatever the best use is for your savings, direct it there – you’ll be surprised the effect compound interest can have on this simple habit. A buffer of ready cash, years off your mortgage or a boost to your super – the benefits are yours for the taking!

Other ways to tap into that optimism:

Our optimism bias has us thinking we’ll be better without changing our behaviour - but it’s unlikely you’ll become ‘future you’ without at least making some subtle changes. How much has your ‘future you’ amassed in savings?  How long will it take ‘present you’ to save that much with your current savings plan?

  • Given that studies in the area suggest we’re more likely to pay off debt than we are to replenish our savings, consider setting up a repayment plan to ‘future you’ for a debt. Even title the transfers ‘debt repayment’ in the transaction description. Determine the amount you want to owe ‘future you’, and how long you think you can maintain that disciplined savings (and take into account how long ‘future you’ could keep up that discipline for inspiration). Nominate a monthly amount you can stick to, and won’t be discouraged or resentful of, to support your target.
  • And while you’re in your internet banking, download a transaction history for the last month and split out what you’re spending. Total up the withdrawals out of your account, and write down an estimate of what you spent on groceries, utilities, sports, take-aways and other items that you know are a part of your expenses.
  • Next to your estimates, write down the accurate figures as determined by reviewing the transaction list.
  • Here’s a great opportunity to look at how the optimism bias is working on ‘present you’ – how you think you spend and how you do, and compare this with what you think the spending habits of fit, healthy, savings and spending savvy ‘future you’ must be Any room for improvement, ‘present you’?
  • Does ‘future you’ have a bit more knowledge about things than ‘present you’? Chances are they do, so help yourself out and commit to reading something on a topic you’d like to know more about once a week. Sign up for a newsletter (like this one), read an article or ask someone a question about a topic you’d like to increase your awareness of – remember, the only ‘silly question’ is the one that isn’t asked.

Applying the steps above will help you on the path to becoming ‘future you’.

Not only will you feel like you should become a ‘better self’ as time marches on, you actually will be!

Shayne Sommer is a Financial Adviser with Shadforth Financial Group. This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from a financial adviser and seek tax advice from a registered tax agent.  

[1] See https://www.sciencedirect.com/science/article/pii/S0960982211011912, or https://en.wikipedia.org/wiki/Optimism_bias  and https://www.youtube.com/watch?v=PIlVeY-rZpc

[2] Claudia Hammond, Mind over Money

The opinions expressed in this content are those of the author shown, and do not necessarily represent those of No More Practice Education Pty Ltd or its related entities. All content is intended for a professional financial adviser audience only and does not constitute financial advice. To view our full terms and conditions, click here.

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