Why we do what we do with our money

“One’s philosophy is not expressed in words; it is expressed in the choices one makes. In the long run, we shape our lives and we shape ourselves. The process never ends until we die. And, the choices we make are ultimately our own responsibility.” Eleanor Roosevelt

In our lives we make rational choices. We weigh up the evidence. We act on the basis of fact, not instinct, not fear, nor emotion. That’s at least what we wish to believe. The belief that humans act as rational beings has dominated academic theory for decades, but that theory is being challenged as too simplistic. Psychologists in the field of behavioural finance are convinced that our emotions heavily influence our financial decisions and can lead us to make irrational choices when it comes to saving or spending our money.

This matters because if we can understand what drives our behaviour, we can modify our behaviour. By modifying our behaviour we can achieve better outcomes and become lifelong savers, committed to delivering a better future for ourselves and our families.

Emotion significantly influences how we invest

Leading behavioural economists Daniel Kahneman, Amos Tversky and Richard Thaler have studied why people spend or save and often act against their own best interests. Their conclusion is that our behaviour can’t be explained by the usual economic theories.

It is not that heart overrules head; different parts of our brains fight for supremacy over our decision-making: the ‘lizard brain’ versus the ‘thinking brain’. An example of ‘lizard brain’ spending would be an impulse buy – that shiny new sports car – which provides immediate gratification, versus the thinking brain that would seek to save for a longer-term objective such as retirement. In the ‘battle of the brains’, for the thinking brain to prevail, we must be conscious of, and be active in, controlling our impulses. The key is an ability to defer gratification. To work towards a goal. Of course that sounds easy to say, but is much harder to do.

The role of aspiration

Psychologist George Katona devoted a great deal of research to determine why individuals choose to defer gratification or not, to save or to spend. According to Katona, consumer behaviour is a function of different economic stimuli and intervening variables within an individual such as personality, attitudes, expectations, and motives.

For Katona, our savings habits relate to an individual’s level of aspiration – a goal – and that to succeed that aspiration would need to be a realistic, attainable goal. Aspirations are not static, they tend to grow with achievement and decline with failure.

Katona found that when achievement exceeds the level of aspiration, the individual experiences success and is satisfied. When the achievement is lower than the level of aspiration, you feel dissatisfied. In both cases you’ll change your level of aspiration: in the former case raising it, in the latter lowering it.

It follows that saving plans need to be set at a realistic level and within a timeframe that will allow one to achieve them.

Interestingly, saving towards a goal is habit forming. In his research Katona found that people still continued to save even after they had achieved their goal, say a house purchase. After saving to buy your dream house, you are more likely to carry on saving and working towards other goals, even though you have already achieved what you originally set out to achieve.

Envisioning the future of savings

So what stands in the way of us all setting our goals and achieving our aspirations? First of all, our ‘wants’. Wants are a form of self-gratification. When satisfying ‘wants’ we generally create immediacy around the outcome. Research has shown that people with different personalities have different timelines when it comes to seeking to satisfy their wants: some ‘want’ immediately; others will postpone this want.

Secondly, time matters. Delaying gratification has limits for all of us. A 2001 study demonstrated that if a reward will not be granted for an extensive amount of time, such as 15 to 25 years, the monetary amount of the reward becomes inconsequential. The bulk of the participants in the research chose the immediate reward, even if their delayed reward would be quite large. For most of us, a delay in receiving gratification can only be so long before it is judged to not be worth the effort to wait. Therefore, it is recommended to have short term goals in place to complement your longer term aspirations.

People should imagine themselves as two people: a current self and a future self. One must create a desired state for your future self and imagine yourself in that place: financial security in years to come, a comfortable and enjoyable retirement, that trip round the world that you have been promising yourselves for years. It must be something you really want – something that gives you purpose. If it isn’t, the motivation to get there won’t be strong enough to complete the journey. We need to picture ourselves in that future moment. That ‘yes’ moment when the dream is realised.

Success is all in the planning. Saving as a concept may not be exciting but what you can achieve or fulfil at the end of it is. Set a meaningful, attainable, rewarding and time-based goal and then create a personalised spending and savings plan. Ensure that the plan has clearly defined objectives so that success is measurable, and outline what this will look like when the goal is attained. At FPI we have digital solutions so that you can track your own progress.

Most importantly, don’t forget to keep imagining the day when that goal is realised.

References: Daniel Kahneman; Amos Tversky, Prospect Theory:
An Analysis of Decision under Risk – Econometrica, Vol. 47, No. 2. (Mar., 1979), pp. 263-292.
Richard Thaler:
Misbehaving, The making of behavioural economics, Quasi-Rational Economics, The Winners Curse: Paradoxes and Anomalies of Economic Life, Nudge: Improving Decisions about Health, Wealth and Happiness
George Katona had a doctor’s degree in experimental psychology at the University of Gottingen. He directed the Economic Behaviour Program of the research Centre for the University of Michigan and in 1950 was appointed professor of economics and of psychology at the University of Michigan

Adrian Emery – CEO FPI

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