Our fiscal brains need schooling
Sidestep your cognitive biases with some straightforward savings steps
Managing your money is common sense, right? Make a budget, do some math, spend less than you earn and you’ll reach millionaire status in no time. Perfect, right? Not so fast. The problem is humans are not always logical with money. Rational Canadians would agree it’s sensible to save a portion of income while avoiding debt.
But with the national savings rate dipping to 3.4 per cent and our household debt at 171 per cent — meaning Canadians owe $1.71 for every dollar of disposable income — it appears that something is getting the better of us and our money.
While many factors are at play, the field of behavioural economics blames
our brains and a series of cognitive biases for our lack of logical sense with money.
Behavioural economics is an interdisciplinary science that combines psychology, economics and neuroscience. It attempts to understand human behaviour and explain why we make “predictably irrational” choices in life.
Since my budget spreadsheets and own bias for compound interest calculators may not be enough to change your money habits, I spoke with behavioural scientist Michelle Hilscher, senior associate at BEworks.
The management consulting firm specializes in applying behavioural science techniques in business to uncover cognitive biases, emotions and mental tricks to rewire your brain to help you better manage money. Check your present bias and precommit: Debt is easy and saving is hard — this line of thinking comes from our tendency to focus on gratification in the present over a payoff in the future.
This phenomenon is called “present bias,” and it’s toxic to sticking to a financial plan, leading to decisions you’ll regret in the future.
“What’s been found is that you feel no connection, or very little connection, to your future self. It’s as if they are a stranger,” Hilscher says. “Therefore, you’re not really willing to make in-the-moment sacrifices on behalf of that person.”
To help counter present bias, Hilscher suggests we cut our brain out of the decision-making process with a precommitment device. This is a way to lock yourself into following a plan of action you might not want to do but which you know is good for you.
So, for instance, precommiting a portion of your next raise to a savings plan with an automatic deduction directly from your paycheque could build savings because you’re not missing the money now.
“Maybe it’s a tax return, maybe it’s a bonus — the idea is to get people to precommit to saving some amount in the future,” she says. “They’ll save more if they think about it as being something that’s coming to them in the future.” Stop being so optimistic — embrace mental accounting: Despite the negativity on display across social media, we humans have a tendency to be overly optimistic about our abilities while underestimating the likelihood of facing a negative event.
One of those events might be running out of money.
“People are known to be very overconfident, and a lot of research is showing that we’re poor at estimating what we know, don’t know and think we’ll do,” Hilscher says.
To help counter this optimism bias, she suggests checking in with a financial professional who can assess our financial risk and setting a mix of attainable short-term goals combined with longer-term goals.
“There’s lots of evidence to show that you’ll save more if you can earmark where the savings are going and have not only different accounts but also accounts that are tied to specific goals. Like a vacation or retirement, or something more short term, like a new bicycle.”