- Finding ways to save money is only one step;
- Actually putting that money away somewhere useful is true savings.
One in three millennials don’t have a personal budget, and one in 10 don’t bother saving any money at all. On top of this, one in 10 millennials live from one payday to the next and only 18 per cent are worried about their financial future.
Why are we like this? Why is it so hard?
The truth is humans are hard-wired to favour immediate gratification over long-term goals, and that can make saving tricky, even if we earn enough to be able to conserve cash.
Professor Robert Slonim heads the Australian federal government unit tasked with testing how behavioural economics can deliver better public policy, more commonly known as the ‘nudge unit.’
Slonim says the main psychological barrier people face when attempting to save is a bias towards short-term rewards over longer-term payoffs - a phenomenon called present bias.
"We tend to focus a lot of our attention and energy in the benefits we receive in the present, and we tend to discount very heavily what's happening in the future," he says.
"We see this with savings and with many other decisions."
When faced with the choice of getting $20 now or $30 next month, most people will opt for the immediate, but lesser, reward.
On top of our present bias, we can often confuse what constitutes saving money.
If you’ve cut back your car insurance, negotiated a lower interest rate on your credit card—or nabbed a great deal on a new TV. You’re congratulating yourself for being a smart saver and keeping more of your hard-earned money in your pocket.
However, you haven’t saved anything yet.
This may seem obvious, but Peter Tufano, professor of consumer finance at Harvard Business School, says many people confuse a lowered rate (on car insurance), or getting a discount (25% off a TV) with saving money. “It’s not savings until you save it,” he said.
Let’s break this down.
Let’s say you were paying $250 per week in rent. When the time comes to renew your lease, you negotiate with your landlord to pay $200 per week. Now, this is where people get confused. With $50 extra a week, it’s easy to think you’ve already ‘saved’ that money, so it can go straight into Saturday night’s fund. That’s not saving. To save, you need to turn the $50 a week into real cash.
Sounds easy, but it’s not. Making sure mental savings morph into actual cash in your account is one area where your brain isn’t your best financial friend. You can thank a psychological phenomenon that economists have dubbed malleable mental accounting. We have covered mental accounting in more detail in a previous blog if you want to brush up on your knowledge.
Mental accounting stands in contrast to real-life number-crunching. If you transfer $50 from your everyday account to your savings account, for example, there are clear-cut steps you have to take, from logging onto your accounts, selecting the transfer option, filling in the fields, etc.
Your brain takes a more flexible, sometimes freewheeling approach. In the rent example above, once you have secured the cheaper rent, your mind now believes it has an extra $50 to play with.
In reality, the money you’ve saved on your rent is still theoretical. At this stage, because of the fuzzy nature of mental accounting, and because any reduction in price or fee only means you’re paying less, not saving more, action is required to transform this into savings.
Whether that action is depositing the said $50 into a savings account or hiding it under the mattress, you are morphing it into savings. Or maybe, think about investing it.
Here is a step by step introduction to the weird and wonderful world of investing. Good luck!