Saving money is hard. Spending money is easy. Hard to argue with that, right? You have that goal in mind, save 10-20% of your income every month. But you rarely make it. Somehow money just seems to be melting away like early winter snow. Poor spending habits and too many nights out might be partly to blame, but have you ever wondered that there might be other factors contributing to it? In other words, it might not all be your own fault!
The Pain of Paying
One of the reasons why spending money has become so easy and putting it aside so hard is, in behavioral economics terms, a ‘reduced pain of paying’. The ‘pain of paying’ is what we feel when we part with money for whatever reason. According to consumer research, there is a sort of “mental decoupling” going on when consumption is separated from payment. Generally, the physical nature of cash just makes it harder to part with it. If you have ever felt that you seem to be managing your spending better with hard cash on hand, then you have experienced firsthand an increased pain of paying.
The concept of ‘pain of paying’ is at the heart of a lot of savings and money management advice – creating artificial ways of increasing the pain of paying so that you would spend less. An example of this would include the ‘partitioning’ method where you would put physical money in separate envelopes for each spending category. Or another example – putting a physical image of the item you want to save for on your credit card so that it would remind you why you are saving in the first place un thus limit your urge to spend.
Ok, you might work on artificially increasing your pain of paying to not overspend on silly things. But know that you are alone in your pursuit against the whole world of business and finance that is trying to persuade you to spend and is constantly creating ever easier ways to part with your money.
Paying hard cash directly was the way it used to be for most things. You would reach for your wallet, count the money, physically transfer it to someone and suffer a bit in the process. Paying with a credit card used to involve punching in your pin number or sign a piece of paper (a small, but physical effort). Nowadays paying with a contactless card or your phone only includes a quick swipe. And add to that that most shopping happens over the internet where making a purchase is just a few clicks with a mouse. It’s the perfection of consumption.
What you have to understand is that most commercial organizations and financial institutions are doing their best and employing the smartest people in the world to find easier, faster and more effortless ways for you to part with your cash. This, like most technological progress, is not bad per se. It just makes it so much harder for all of us to resist our urge to spend. Now imagine that these same organizations would put all their effort and money into convincing you to think twice before spending. Seems quite silly right?
The Pain of Saving
With financial technology and innovation driving down the pain of paying saving becomes ever more difficult, i.e. the pain of saving is effectively increasing. So, the question becomes whether there are ways we can reduce this increasing pain and effectively incentivize ourselves to save more.
To answer this question, it is worth to look once more into behavioral science and, more specifically, into the theory of ‘nudging’. Nudging is “any aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives. To count as a mere nudge, the intervention must be easy and cheap to avoid. Nudges are not mandates. Putting fruit at eye level counts as a nudge. Banning junk food does not.” (Thaler & Sunstein 2008, p. 6). Examples of nudging in an everyday context would include telling you that other people in your neighborhood have already signed up so you should too (i.e. social norming) or selling you something with the text that the offer is only available today (i.e. loss aversion).
Putting this in the context of saving, this means that strict mandates like the advice usually given to save 10-20% of your income are not likely to work. Instead, you want to find ways to alter people’s behavior so that it feels inobtrusive and natural, i.e. people need to want to do it instead of feeling that hey have to.
Nudging you to Save
While no particular savings nudge will absolutely guarantee that you start building up some savings, there are a few techniques that are grounded in behavioral science that might do the trick for you.
Generally, if people have to actively think about saving, then they probably won’t do it. Thus you can think about ways of taking out the ‘active’ part and make these decisions automatic or have them made for you. A good example of this would include setting up daily automatic deposits of a few euros from your current account. While you do not necessarily feel a few euros every day these will quickly add up. The important part here would be to do this daily, instead of monthly. Even though a single transfer of 150 euros is the same as 30 transfers of 5 euros, we perceive the numbers differently. A single payment of 150 euros is equivalent to a monthly car payment (i.e. a big-ticket item) while daily payments of 5 euros are a few lattes per day (a much smaller ticket).
There is a tendency to think of saving as an either-or question. You either save money or you don’t save money. This thinking leads to ambitious attempts to save a significant proportion of income right from day 1 only to realize that you have overstretched your goal and then are going back to saving nothing. A good way to work around this is to start really small and increase your contributions monthly, quarterly or perhaps every time you get a pay raise. Start with 1 euro per day, then increase that to 2 euros after a month or two, then to 3 and so on until you reach a target amount. Taking it slow will allow you to gradually adjust to a smaller spending budget.
And, finally, you can look for help from financial technology. And, no, this does not mean getting a budgeting app. With the arrival of open banking you should see more and more financial apps offering to link up with your bank accounts, analyze your spending and with the help of AI suggest where and how you can save money. As banks open up, you can bet there will be much more innovation around saving same as there has been around making spending effortless.