Biases that keep you from saving money

Understanding cognitive biases can help us to make good quality decisions. If we know where we're likely to go wrong with our thinking, we can take conscious steps to counter these tendencies.

A recent working paper, "The role of time preferences and exponential-growth bias in retirement savings", discusses two biases that make us less likely to save money. (HT: The Atlantic)

These biases are: 

  • Present bias. We tend to give stronger weight to options with immediate payoffs than options with payoffs that are at some point in the future. That is, we are wired to spend now rather than save for the benefit of our future selves.
  • Exponential-growth bias. Even if we intellectually understand the power of compound interest (and many people don't), it is difficult to intuit the profound impact of compound interest/exponential growth in a way that has a concrete effect on our behaviour. In other words, we don't realise how much a dollar saved today will be worth in the long-term future.

At a policy level, schemes like Kiwisaver, which are opt-out and lock funds away until retirement, are a way of countering present bias and taking advantage of the exponential growth that compound interest brings.

At a personal level, having a savings plan and committing to this plan, in a way that is automatic, and keeps funds out of easy reach, is a great way to battle these biases. 

(And when I say "savings plan" in this context, I also mean a "debt reduction" plan. Because reducing debt has the same effect on your net worth as saving money.) 

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Sonnie Bailey

Sonnie is the founder and principal of Fairhaven Wealth.

Before founding Fairhaven Wealth, Sonnie worked in the legal and financial services industries for over a decade.

Sonnie first became involved with financial advice as a specialist financial services lawyer. For many years, he was an “adviser of advisers”, reviewing thousands of advice files prepared by hundreds of financial advisers, and providing feedback in relation to the quality and appropriateness of advice; industry best practice; risk management; and regulatory compliance. He has published work in industry publications and spoken at various financial advice conferences.

Sonnie has also worked with banks, investment management firms, insurers, and derivatives providers.

Sonnie has worked as a private client lawyer, focusing on succession, estate planning and trusts. He ran his own legal firm in Australia before relocating to New Zealand. He has also acted in independent trustee and company director positions.

Sonnie is passionate about helping people achieve their goals and manage the risks to which they are exposed.

He has written extensively on his blog, New Zealand Wealth and Risk, which can be found at www.wealthandrisk.nz.

Sonnie is married to his wonderful wife Chrissy, and has two young children, Ben and Anna.