The science of spending
Finance expert Ted Richards explains how understanding why we spend can you save money.
Have you ever bought something on sale, be it shoes, camping gear or jousting sticks? You didn't really need them, but they were such a bargain! Or do you find it really hard to find the motivation to ring around for a better deal on your electricity or check the fees you are paying on your super, even though you know you should?
When we spend money, there are a few things going on inside our heads that affect our decision-making. We like to believe we're always in control and make rational decisions all the time, but the field of behavioural economics has proven that, when it comes to managing money, we can often be our own worst enemies.
What is a mental bias?
When we make decisions, we often use mental shortcuts to reach an outcome quickly. This has been part of our evolution and has been great to ensure we've survived over thousands of years, but often these mental shortcuts create "mental biases" that influence our decision-making.
When it comes to money and spending it, these biases can cause us to pay too much for something, overspend on our budget, fail to save enough for retirement or make poor investment decisions.
How to take control to save more
The bad news is, it's not enough to simply be aware of these biases; they're just a part of who we are. The good news is, once we know how the biases affect our decision-making, we can put strategies in place to improve those decisions and manage our behaviour when it comes to our money and finances.
Here are four common biases that can influence your financial decisions:
Falling for the fake sale: the anchoring effect
The anchoring effect sometimes nudges us to buy something we don't really need or tricks us into paying too much. When a sale comes up, it's important to ask – how genuine are the discounts? If something has a price tag stating it usually sells for $500 but it's marked down to $250, the excited feeling at the prospect of getting a bargain is the anchoring effect at play!
How to beat it: The seller simply stated the item used to be $500. Was it really? Avoid falling for fake discounts by doing some research online before hitting the shops.
Unrealistic fear of change
Sometimes we can incorrectly perceive any change from the status quo as a loss. This often stops us from researching other options and making necessary changes to our investments and suppliers.
In other words, we tend to weigh the potential losses of switching from the status quo more heavily than the potential gains, which can lead us to avoid making a change at all. This can mean we get stuck paying too much with our utility suppliers, insurance companies and even a poorly performing superannuation fund simply because we assumed the status quo was the best choice for us. This bias often prevents us from saving money.
How to beat it: Doing lots of research and looking at the fine print will provide reassurance that, sometimes, change is for the best.
Thinking things will stay the same
At the point of potential purchase, we often believe that we'll love something forever, therefore justifying the decision. The truth is, our likes, dislikes and needs can change quickly, and it's rarely the case that we love something eternally. This can also affect our financial planning because we assume the way our situation is now will continue into the future.
How to beat it: While we don't have a crystal ball to foresee the future, forward-planning and anticipating the needs of our future self can be useful and prevent us from making choices that may be unsuitable or choosing strategies that could tie up money we may need to access in the future.
The need for instant gratification
We usually give more importance to rewards that are closer to the present than we do to rewards that we'll receive in the future – and this often works against us with our money. Saving money or making long-term investments result in benefits that we usually see further into the future (like in retirement), which makes them less appealing to our minds. Meanwhile, choosing to spend money on takeaway or buying a new car gives immediate perceived benefits.
How to beat it: The best way to start getting around this one is by constantly reminding ourselves of the REAL rewards – the ones that aren't instantly felt and take a little dedication and patience but are well worth the wait.