We’ve all met somebody brilliant at managing their money and somebody equally disastrous at keeping on top of their personal finances. But what separates the savvy saver from the debt-saddled frivolous spender? And how can a person struggling with their personal finances really transform their psychological approach to saving money?
These questions are all the more important when you consider the importance of healthy finances for our mental health. A survey by the American Psychological Association, for example, found that some 72 percent of Americans felt stressed about money at least once in the prior month.
And thankfully there is now ample research to begin answering these questions. Behavioural economics and psychological research offers some interesting advice on how we can use the workings of our brains to foster a savings mind-set.
Automating your finances
The frugal living blogging community extolls the benefits of automating your savings and investments – and with good reason. In short, the automation of personal finances is about setting up automatic transfers and payments into savings accounts, investments and financial commitments periodically.
The approach isn’t fool proof, but it strips away the opportunity to spend the money moved on impulse and instead tucks it away for the future. And with automatic transfers and payments, your money is allocated where it is needed as soon as it arrives, without having to grapple with difficult spending decisions. In other words, your money is on ‘autopilot’, making it a lot easier to make the responsible choices with your money.
Not only should this reduce stress levels and time devoted to managing your money, but evidence from psychological studies suggests you will actually save greater amounts over the long term.
Nava Ashraf, Dean Karlan and Wesley Yin published research in the Quarterly Journal of Economics in 2006, for example, which demonstrated that automating transfers to accounts with time or total value criteria created lasting changes in savings approaches.
What’s more, research from Roy Baumeister and his colleagues at Case Western Reserve University showed that our willpower muscles can get tired. And while our willpower is most run down we are more likely to overspend and make less responsible financial decisions. The role of automation of our finances – to make more responsible decisions with our money on autopilot – can therefore mitigate the risk posed by willpower fatigue.
Tracking your finances
As well as offering a raft of other potential financial benefits, setting up a proper system for tracking your personal finances can also act as an impetus for psychological change. Checking balances regularly, understanding your net worth and holding yourself accountable based on those figures can foster significant financial benefits.
A study by Shlomo Benartzi and Yaron Levi found that study participants using a mobile app to track spending and investment performance reduced their spending by nearly 16 percent. And similar research by the Federal Reserve in 2016 found that 62 percent of mobile banking users checked their account balance before making a large purchase in the 12 months prior to the survey, and half of them decided not to purchase an item as a result of their account balance or credit limit.
So it’s clear that increased awareness of our personal finances drives behavioural change in our spending and investing patterns. And with the new technologies at our disposal, driving that awareness of our personal finances and creating a positive habit of tracking our money is now easier than ever before.
Goal setting and small wins
Automating and tracking your personal finances are evidentially great ways to create a positive savings mind-set, but they’re not a silver bullet. Our saving habits can fall away as our motivation wanes. Forming and achieving specific goals can therefore play a crucial role in sustaining motivation and engraining new habits.
Charles Duhigg explains this brilliantly in his book, The Power of Habit. In short, he outlines that how we form positive – and negative – habits depends on a habit loop that we all adopt unthinkingly in our neurological make-up. These habits are fortified by associative rewards and can only be formed through the adoption of particular behaviour patterns.
Of course, in order to form these new behaviour patterns there must be some underlying motivation to behave. And that’s where goal setting comes in. The achievement of goals has been shown to have a positive impact on savings motivation so can act to maintain a savings mind-set. Our brains produce higher levels of dopamine upon achieving our short-term goals, which acts to reinforce new behavioural patterns.
But don’t set over-reaching goals or overdo the number of savings goals. Research from Dilip Soman and Min Zhao published in the Journal of Marketing Research suggests a single well-defined savings goal fosters higher ‘implementation intention’ than multiple savings goals – in other words, providing a more powerful spur for actually saving money.
My tip: Celebrate success, but keep your eye on the prize
All this automating, tracking and goal-setting can still take its toll. The words budgeting, pension planning or cost cutting are not exactly bright sparks of motivation. Indeed, the reality is that they tend to bring associative ideas of deprivation, sacrifice and even unhappiness to the surface.
So how can we reinforce positive ideas to go with this journey towards shifting our mind-sets?
The big rewards for saving and investing are often deferred for the long term, so as you achieve short-term wins it’s worth celebrating your successes to reinforce the change journey further. As already mentioned, there is ample research out there on the benefits of short-term wins for habit formation, but the occasional reward above and beyond just achieving your short-term goals can make the journey all the more enjoyable.
Why not treat yourself to a meal out for hitting your saving target for the month? Or buy that jacket you’ve had your eye on for a while? So long as your treat is reasonably priced, it’s not going to set you back dramatically on your journey. In fact, it may just reinforce your new found savings habits.
And a possible bonus from flexing those willpower muscles…
While we make changes to the way we think about money, we’re flexing our willpower muscles in new ways. Our newfound awareness of our net worth is challenging our previous levels of impulsivity. We are starting to say no to unnecessary costs and yes to frugality. And research suggests that this savings mind-set may yield more results than just the financial ones.
Back in 2006, Megan Oaten and Ken Cheng published some interesting research on willpower. They asked participants in a study to undertake a money management programme, which involved similar exercises such as tracking and automating their finances, and setting goals and targets.
Unsurprisingly, their personal finance situations improved. But incredibly, the researchers found that participants were also smoking fewer cigarettes, drinking less alcohol and caffeine, and eating less junk food. What’s more, the participants were found to be more productive at work or university. As Charles Duhigg puts it, “once willpower became stronger, it touched everything.”
So there you have it: automate and track your money, set goals and celebrate short-term wins. And who knows, you may just lose weight and work more productively while you’re at it.