“Hello everyone! Today I have a great post from Jeffrey Hull, who is the founder of Savvy Financial, a financial technology firm that is making the college savings process simple and enjoyable for busy families.” – Vincent
Have you ever wondered why you are so bad at saving money? I mean, you have the intention to save, but something just always comes up. Luckily for you, today is the day you will have your answer…and some solutions to your problem!
Do You Control Your Brain, Or…
Behavioral psychologists and economists have studied why you are bad at saving. The truth is, evolution has done a number on you. To illustrate this point, take a look at the two tables below, and figure out which of the two is longer.
Simple enough, right? The one on the left is longer. So, what does that have to do with your savings habits?
Take out your closest measuring device (your finger may work for this one), and compare the long dimension of each table. Then measure and compare the short sides. I’ll give you a few moments…
If you measured correctly, you should be shocked. The punchline is that both tables are the EXACT SAME SIZE! Measure again if you don’t believe me.
This illustration works whether or not you have seen it before, because no matter how many times you measure, you just can’t convince your brain that both tables have the same dimensions. The truth is, we only have control over a certain portion of our brain. As savers, our brain exerts a certain amount of influence over our decisions that we are often not even aware of.
You Only Think You Know What You Want
If the optical illusion alone doesn’t convince you that your brain is working against you, check out this behavioral economics study. In this study, researchers compared people’s preferences for a smaller monetary amount earlier to a larger monetary amount later.
I mimicked the study with readers of Savvy Financial’s blog to make it easier for us non-scientists to understand. You can participate as well. Take a look at the two following scenarios, and pick which option in each scenario you would prefer.
1. You can have $100 today or $110 in a week
2. You can have $100 in a year or $110 in a year + one week
The results of SavvyFi’s study indicated that 90% of survey participants wanted $100 today, and 75% of participants wanted $110 in a year + one week. Interestingly, survey participants are willing to wait seven days for $10 in one scenario but not the other.
A problem arises when we fast forward to a year from now. At that time, if we are not committed to our decision from a year ago, we will likely change our mind and take the $100, forgoing the extra $10 seven days later. In one year from now, Scenario 2 turns into Scenario 1, and we all of a sudden don’t want to wait seven days for the extra $10. There goes our brain messing with our well-laid plans.
Tricks To Save Money More Effectively
Because researchers have studied how we make decisions, we have been able to design better money saving techniques to work around our brain’s quirks. The following are several tricks to hack your brain and save money more effectively.
1. Break Your Long-Term Goals Down To A Monthly Or Daily Savings Goal
Being able to break down your overall savings goal into a monthly or daily savings number can be a good motivator. Because our brains are short-term biased, we care a great deal about what we have to give up in the immediate future. However, as the previous preference reversal study shows, we care much less about what we give up later in the future.
By comparing a small amount that we have to give up in the immediate future to a large amount that we gain later on, our brains are tricked into thinking we are giving up very little to get something really big. It doesn’t fully comprehend the effect of time months out from today. Take a look at the statements below, and see if you agree.
- If you save $1.50 a day, you could have over $3,000 saved in five years.
- If you save $45 a month, you could have over $3,000 saved in five years.
- If you save $550 a year, you could have over $3,000 saved in five years.
- If you save $1.50 a day, you could have almost $19,000 saved in twenty years.
- If you save $45 a month, you could have almost $19,000 saved in twenty years.
- If you save $550 a year, you could have almost $19,000 saved in twenty years.
Note: The “five year” statements are all equivalent to each other, as are the “twenty year” statements.
2. Start Saving “Tomorrow”
2017 Nobel Prize Winning Economist Richard Thaler conducted studies on workplace savings programs with low employee participation, which led to a program he dubbed the “Save More Tomorrow (SMarT)” program.
In the study, a financial consultant recommended a savings rate to each employee, of which 28% adopted the recommendation. For those that didn’t, the consultant recommended that they increase their savings rate on their next raise and each raise after. Of the group that declined the first recommendation, 78% adopted the second plan and eventually wound up with much higher savings rates than the first group.
You can do the same. With your favorite automatic savings tool (most banks have an online tool for this), set yourself up to automatically start saving at some point in the future. Better yet, set this amount to gradually increase every month.
Here’s an example of how this can work for you. If you start with $1 next month and save an additional dollar each month (i.e., $2 in month two, $3 in month three, etc.), you could save almost $9,000 in ten years. Every month, you would only be saving one more dollar, so it would have very little impact on your budget.
3. Save The Change
If the previous recommendations don’t work for you, or if you don’t have access to technology that has those features, there are many “save the change” applications that allow you to save without thinking about it. This takes your quirky brain out of the equation, so it can’t sabotage your plans.
Save the change programs work just as their name suggests. When you swipe your card for your $4.75 latte, the remaining 25 cents are moved to your savings account. Some programs also allow you to save a certain dollar amount every time you go to your favorite coffee shop (or other location), and others use algorithms to periodically move money to your savings account depending on how much the algorithm decides that you can afford to save.
These mechanisms can work well; however, if you can hack your brain using the first two methods, you can generally accomplish your financial goals much more effectively.
Jeffrey Hull is founder of Savvy Financial, a financial technology firm that is making the college savings process simple and enjoyable for busy families. In addition, Jeffrey frequently writes about college savings and financial decision-making, focusing on how personal finances can be simplified into an intuitive process that aligns with the way humans naturally think. You can follow Jeffrey and Savvy Financial at SavvyFi’s Facebook page and blog.