If you are like the average person, your estimate will be a long way off. People have a tendency to be optimistic and overconfident about managing their money. It’s one of the six “behavioural hurdles” that are particularly problematic for financial capability. A report by the London think tank RSA, which I co-authored, details these thinking traps. Some highlights and tips on how to overcome these behavioural hurdles are explained below.
Having a lot on your mind can result in sub-optimal choices. This is because in this state we tend to pick the simplest option, which is not necessarily the best option. When faced with many different decisions, or having to make trade-offs (for example when there is not enough money or time to do everything), it can feel as if all of our mental energy is being zapped.
Ever go for a night out with friends expecting to only spend a certain amount, and wake up the next morning realising you’ve spent double that? Or go grocery shopping while hungry and end up with extra food that will end up being wasted? In the heat of the moment we sometimes spend very differently to the way we spend when in a “cool state”. It’s almost as if our cool self can’t empathise with our hot self, and vice versa.
Optimism and overconfidence
We tend to have an overly rosy outlook on the future and be overconfident about our abilities. It sounds pleasant but it can actually lead to stress. A survey published by Ipsos Mori in Britain in July 2015 found that, on average, people believe the cost of raising a child to age 21 is £50,000 when in reality the estimate is closer to £229,000. The respondents believe that to get £25k per year retirement income for 20 years they’ll only need to have saved a pension pot of £124,000. The amount required is closer to £315,000.
It can be very hard to wait for something better when something good is available right now; just watch these young children trying to put off eating a treat in the hope of getting two treats later. Our desire to have things now means we sometimes spend impulsively, which can damage a bank balance.
One coffee won’t break the bank, but years of them really add up. And when the habit is more expensive – like using credit cards to purchase non-essentials rather than saving up for them, incurring high interest payments – the problem is more evident.
The actions of other people have a strong effect on our own behaviour. Trying to fit in (even subconsciously) can result in herd behaviour. The problem with social norms when it comes to financial capability is that buying is much more visible than saving, so it is more “contagious”. This can lead to pressure to “keep up with the Joneses”.
Avoiding these problems can be difficult, but here are a few tips that may help.
- If you are feeling cognitively overloaded, try asking a trusted friend or family member who has a clear head for a second opinion to help you make the decision.
- To address empathy gaps, consider making a shopping list (and keeping to it). On a night out, stick to cash and only bring as much as you are comfortable spending.
- To avoid negative effects of optimism and overconfidence when planning for a child, retirement or other life event, try thinking of a range for the costs rather than a single estimate. This gives a better indication and the ability to plan using different parts of the range.
- To help delay gratification, set savings goals to highlight to yourself the future benefits of saving now and enjoying later.
- To reduce harmful habits, consider trying to avoid the triggers, perhaps by changing your routine. A new route to work, or going to a different supermarket might help you out of autopilot mode.
- Try using social influence to your benefit by announcing your financial goals to trusted friends or family. This may provide social support to help you to commit to those goals.