- Recognise the needs behind your spending
- Avoid the status trap
- Factor in inflation
- Build the skill of saving
- Kick-start change with the “Fresh-Start Effect”
Each New Year we make a few resolutions: get fit, stop drinking, start saving. We’ve all been there. Still, by Easter, most of us have already given up.
I know I have. (My half-marathon training has been flagging…)
And when it comes to money, breaking bad habits is just as hard as giving up booze.
With Easter behind us for another year, and after enjoying a few too many Easter eggs, there’s no better time to review our resolutions.
The good news is, behavioural psychology can help (I know, bear with me). Morningstar’s senior behavioural scientist Sarah Newcomb, points to five clear ways we can have more success with money in 2018.
1) Recognise the needs behind your spending
“We always hear about how if we didn’t go to the cafe every day we could save around $1,400 a year. Making coffee in the office might work for a day or two, but the reason you go to the cafe probably has nothing to do with caffeine,” says Newcomb. “You’re probably meeting a different need than a need for caffeine. You find yourself back at the cafe. People don’t go out to eat dinner because they need food. They do it because they want to connect with friends or experience something novel. They’re meeting needs for social connections, for convenience. If you cut something out of your expenses without tracing it back to the need that you’re meeting, the expense goes away but the need doesn’t—it stays there and gets louder and louder until you finally meet it.”
Good budgeting, then, will restructure financial priorities to meet your underlying needs, without sacrificing the needs of your future self.
2) Avoid the status trap
Pressure to spend can also arise as we try to “keep up with the Joneses”. Newcomb says that the trade-offs between spending for today and focusing on the future can be made more easily when you understand that most people struggle with the same decisions—and they aren’t necessarily making good choices.
“We have to recognize that the people around us who seem to have it all probably don’t,” Newcomb said. “You can see people going out and spending and driving great cars and living in great houses and always having the new gadgets but remember that six to seven out of every 10 of them are also losing sleep over their money. I think that can help when you’re considering your own trade-off and say, ‘Who do I want to be? Do I want to be the guy that looks like I have it all, but it could fall apart any second? Or do I want to be the one who’s got his head on straight and has real security?’ Be the guy whose friends ask him for financial advice. That’s real status.”
3) Factor in inflation
Choosing to invest for the long term can be difficult. “People—young people especially, need to also take stock of their long-term needs, like the need for financial security. They’re 22 and finish their studies, and they get a job and say, ‘I’m 22, I do not need to start saving for retirement now,’” Newcomb says.
“But at 2.5% inflation, prices on everything double every 28 years. If you get out of uni at 22 and the lifestyle that you’re comfortable with costs you $50,000, by the time you’re 50, that exact same lifestyle will cost $100,000 a year. At 74, the lifestyle that cost you $50,000 when you were 22 will cost you $200,000 a year.”
“Also, people think about how much their lifestyle’s going to cost them on day one of retirement, but they forget about year 25. They end up in their 90s on a fixed income, which essentially means their buying power is going down every single year. That’s why you have to start with, ‘What lifestyle do I want to live? What will be comfortable for me? What will that cost me in the future?’ When you really start looking through the numbers then you say, ‘Oh crap! I have got to start saving.’”
The key, then, is to identify what’s important to you and what lifestyle you want for the future. Then, work backwards from that to find a present-day plan that takes those goals – and inflation – into account.
4) Build the skill of saving
Learning to save is essential. “We tend to think, ‘I’m either a spender or a saver.’ Saving is a skill,” Newcomb says. “You don’t say, ‘I’m going to become a runner,’ and start by signing up for a marathon. You start by running around the block because it takes a lot for your body to build endurance. You have to do it slowly over time, and it’s the same with saving.”
“If you’re naturally a spender, you’ll tend to associate money with things like freedom, opportunity, and fun, and you’re thinking about all the things you can do with the money. It’s those experiences that you’re looking for, rather than the feeling of saving. Saving feels painful because if you are a spender, saving means that you’re not getting the stuff that you want. You feel like you’re depriving yourself.
“If you are a saver, on the other hand, you probably associate money with the feelings of security and safety, and you feel freer when you have money in the bank than when you’re spending your money. Savers are lucky people who naturally just love holding on to money—they don’t need to build the skill of saving. They understand that. Those of us who are spenders, have to slowly build it up. “You don’t go from being a spender to having a down payment on a house right away. You do it little by little, by training yourself to save. It’s like exercise rather than dieting: You build your strength over time.”
5) Kick-start change with the “Fresh-Start Effect”
As a clear financial plan comes into focus, use what behavioural scientists call the “fresh-start effect” to make your plan stick.
“When we think of something as being a fresh start, we are naturally motivated to put our best efforts into reaching our goals,” Newcomb says. “That fresh start can be the start of a week, New Year’s, a birthday, the start of a season,” or another landmark in time.
Research clearly supports this: In a study done by Wharton University scientists, people were asked to describe a goal that they would like to accomplish, then they were asked when they would like to get an email message reminding them of that goal. Some of the participants were given the option to choose the first day of Spring as a date for the reminder; others were given the option of choosing the third Thursday in March. Those both occurred on the same day, but participants overwhelmingly chose the first day of Spring.
“It’s worthwhile to take advantage of the fresh-start effect and not ask, ‘Fresh start in 2018, what do I want to do?’ but instead, ‘Fresh start in 2018. Who do I want to be?’”
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