Saving money for a new car, planning a trip, paying unforeseen expenses and getting ready to retire are some goals we may strive for in life. However, what we do every day may cut our future plans short. Why? The answer is in our head.
Saving is a core part of personal finance management and helps us maintain good financial health. However, time and again, we get distracted by deals, sales and new products. Our brain automatically tends to think about now instead of the future, showing a preference for immediate returns over long-term well-being. That's why we find it so easy to give in to sales and discounts yet so hard to save for retirement, buying a home, planning the trip of our dreams and other financial goals.
This behaviour has to do with the “present bias”, a theory developed by Richard Thaler, a US economist and winner of the 2017 Nobel Prize in Economic Sciences for his work on behavioural economics and psychology.
This “Finanzas para Mortales" (Finance for Mortals) article (in Spanish) shows how feelings influence “homo economicus”, a prominent term in the first half of the 20th century for people who are moved by their desire to achieve utmost satisfaction.
How to eliminate the present bias
Meet Samuel. He’s 35 years old and has been thinking about saving for retirement for some time. With his university days long behind him, he now has a stable job and a salary that covers his rent, transport, bills and other monthly expenses. He also likes to go to the cinema, travel and buy the newest video games.
He may not think so, but unforeseen expenses rooted in the present bias are reducing his savings and he never remembers to put money away to achieve his goal. Next, let's see how making small adjustments to his behaviour could help boost his financial health:
That way, Samuel will understand and manage his finances much better. He’ll see his savings start to grow along with his ability to pay for unforeseen costs while reducing his risk of over-indebtedness. His financial health will improve, and he’ll be able to satisfy his current obligations and fulfil his future goals.
Ever heard of the bandwagon effect? This Openbank article (in Spanish) will show you what this aspect of human behaviour is all about.