When you are in your 20s and 30s, you probably hear a lot of: “Just live in the moment! Enjoy being young!” You also get a lot of this: “Start saving money now to prepare for your retirement.”
You can probably imagine which advice most people prefer. Yup, you got it. Young adults simply don’t like thinking about the future and this makes it challenging to save money.
Social psychology helps shed a light on some hard-wired biases that make many people reluctant to save for the future. And, by understanding these human behaviors, you can then get out of your own way. This, in turn, will help you make more level-headed decisions about your money. To get started, take a look at 5 tips to help you understand your own biases so that you have a better shot at a secure financial future:
1. Ask for outside opinions and help.
Before making a big financial decision, acknowledge you could be wrong and ask for advice from someone you trust. Why? Because we all have our biases and this means you may not perceive your situation objectively – especially if your emotions get in the way. In fact, we often pick out those bits of data that make us feel good because they confirm our prejudices. Socials scientists call this confirmation bias. And, when confirmation bias creeps into financial decisions, it can lead to snap decisions.
An objective expert, on the other hand, will have no problem giving you advice – whether you like it or not. Here’s another tip: If you talk to a financial advisor, make sure you work with a fee-based advisor rather than one working on commission. As author William Bernstein notes, commission-based advisors may seem a better option, but their financial success is inherently tied to keeping you on retainer.
2. Try not to get overwhelmed with financial decisions
It’s easy to feel overwhelmed when making financial choices, especially with so many options for savings accounts, credit cards, and investments. To make things more complicated, psychologists say that humans only have the cognitive ability to compare up to five options. This is called “decision-paralysis.” This means that you’ll likely look at the first few options and then stop. Otherwise, you may fear that you’ll make the wrong decision.
A good way to make financial decisions without becoming overwhelmed is to separate small decisions from big ones. A small decision, for example, may be choosing which brand of toilet paper to buy. A big decision, on the other hand, is more like carving out the time to talk to a financial planner about a savings plan.
Another tip: If you get stressed about too many decisions, it helps to take a step back, realign your priorities, and address one matter at a time.
3. Be mindful of “mental accounting”
We often assign an emotional value to money that can make it both easier and harder to spend. For example, let’s say you just walked away with a nice tax refund from the IRS. You may feel the urge to splurge because this newly acquired cash isn’t “real” money, right? In contrast, let’s say you just worked a tough 60-hour week and earned some nice overtime pay. In this case, you may want to stash away that extra cash in a savings account because, hey, you earned it!
Credit cards can do this to us too: Spending on credit often doesn’t feel real until the bill comes.
To social scientists, this emotional way of putting money into specific buckets in your mind is called “mental accounting,” according to research in the Journal of Behavioral Decision Making. Mental accounting can be a good thing if it helps you budget. For example, you may assign, say $300 each month to your “food” bucket. However, when you assign emotional value to these buckets of money, the cash becomes different from its real, tangible value. In this case, you may end up spending your entire bucket. For this reason, it’s important to stay mindful of mental accounting.
4. Take financial risks.
In plain terms, the pain of losing money hurts. And this can make just about anyone risk-averse. This is especially true with millennials.
According to CNBC, 74 percent of people under age 35 said: “that they were unwilling to take an above-average or substantial risk with their investments.” In fact, according to CNBC, they are investing “as conservatively as retirees.”
This type of risk-aversion is often called “negativity bias” by social psychologists. In a nutshell, this means that you react more strongly to negative events than positive ones. This, in turn, can manifest in a fear of taking risks. Because millennials grew up in the thick of the financial crisis and a struggling job market, they’ve seen the consequences of financial failure. So, it makes sense that this population segment may prefer playing it safe.
While it’s okay to be cautious with money, it can also prevent you from making financial gains. Yet, if you start investing while you’re young, this will pay off big time. Thanks to compounding interest, you can be well on your way to a nest egg. For example, let’s say you start investing $1,000 a year at age 25, with a hypothetical 10% interest every year. At the end of the first year, you’ll have $1,100. By age 30, if you keep re-investing with the gains you make, you will have $8,900. By age 55, you’ll have more than $214,000. On the other hand, let’s say you invest that $1,000 starting at age 40. By age 55, you’ll only have about $42,000.
5. Don’t succumb to the herd mentality.
According to sociologists, the herd mentality essentially means that you follow others because you don’t know what else to do. When it comes to money matters, it’s easy to get caught up in this. For example, if you buy a new tech stock because everyone else is buying this hot stock right now, you can end up in the dreaded “speculative bubble.” In other words, you may get caught up in the herd. In this case, when people start selling off that stock, even if it’s at a low-point, you may sell it too – potentially losing money.
Before you follow a herd, take a step back and ask if it’s something you want, not just some good investment idea. It’s also a wise move to ask for outside opinions to gauge whether your decision is a smart long-term investment or a fun short-term bet.
Keep in mind that even if you follow these tips, biases are natural. Nonetheless, recognizing how you can change your behavior patterns can serve you well when it comes to making sound financial decisions. There’s only one person blocking your path to a more secure financial future: You.
Are you ready to get out of your own way? Learn more about Chime’s Automatic Savings tools that can help you save money without thinking.