February 12, 2018

This is why we’re always so Broke (& how to Fix That).


A few weeks ago, a client sat in my office and told me about her “a-ha” moment with money.

“It’s taken me 45 years, but I finally think I’ve got some insight into why I’ve never been able to save or get out of debt,” Judy said.

I smiled, eager to learn more and pricked up my ears. Judy always has a wealth of stories, information, and knowledge. She told me about some reading she had been doing on budgeting and saving, citing The Barefoot Investor by Scott Pape as a game-changer.

One thing in particular that she spoke about enthusiastically was how saving should be automated.

Hmmm. This made perfect sense. I made a mental note to do my own digging into the psychology of saving (and spending)—an area I know little about.

That night, I did some googling and came across Richard Thaler, the behavioural economist who won the Nobel Prize for economics last year for his work researching the emotions and behaviours that influence our spending patterns. What Thaler and others said intrigued me. For while no magic panacea exists for wealth creation, there are strategies to support more positive financial wealth. Let’s look at them:

Saving and spending.

From the get-go, we are told we need to save money. But we’re also battling with basic human nature—spending it! Thaler and his peers have extensively researched this contradiction. In a 2009 interview with the Financial Times, Thaler said:

“Conventional economics assumes that people are highly-rational—super-rational—and unemotional. They can calculate like a computer and have no self-control problems. They never over-eat, they never over-drink, they save for retirement, just the right amount—first by calculating how much they need to save, then by religiously putting money aside. Real people are not like that.”

I love that Thaler talks about “real people.” Real people are the ones I see in my clinical practice. And based on the real people I’ve encountered over the years, I can tell you that financial management, much like weight management, does not come easily for many. In a nutshell, Thaler argues that human beings are affected by behavioural biases that then affect our financial choices and thoughts.

So what are these?

The Endowment Effect

The endowment effect looks at emotional attachment to objects. What we own, we value more than what we don’t own. This helps explain why we often have unrealistic ideas about the value of our items we hope to sell.

Loss Aversion

People dislike forfeiting something once they have it. In other words, if you are given something but then have to give it back or have it taken away, the pain of the loss is felt more acutely than the original gain.

A study done on capuchin monkeys by Venkat Lakshminaryanan and colleagues illustrates loss aversion. The researchers set up a trading scenario where monkeys could buy pieces of apple from different sellers. Seller #1 would present one apple piece and hand it over, while seller #2 would present two but then take one away, presenting the monkey with only one piece. Even though both sellers gave the same outcome, the monkeys strongly preferred seller #1. This led the researchers to argue that loss aversion and economic biases are innate in not only in human beings but also in our relatives, monkeys!

Maybe loss aversion explains why even top earners find themselves in tax predicaments, when they bank rather than automate the deduction of their tax from their annual partnership pay-outs. In so doing, they often spend money they believe to be theirs even knowing rationally it is not.

What does all of this mean about budgeting in everyday life and being financially savvy?

Automate, automate, automate.

Many behavioural economists and financial advisors argue that to save money, we need to remove discretion and automate our savings. In other words, to remove the temptation to spend it, put it away before you’ve even seen it. This counteracts loss aversion.

An increase in rounding-up banking services and automated savings apps supports this. Superannuation (compulsory retirement savings) in Australia is a classic example of automated saving—it goes to our fund and is untouchable before we’ve even seen it.

Mindful spending.

Mindfulness is not only a strategy for emotion management but also for financial management. When we take the time to spend and save mindfully, we increase the potential for living within our means and forgoing purchases that do little to enrich our lives.

Know your financial position.

The age-old mantra, “You can’t manage what you don’t measure” rings true for me with money. In today’s busy world, sometimes it’s easier to bury your head in the sand rather than unearth a true picture of your current and forecasted financial position. In taking the time to look at your finances pragmatically, you are far better equipped to manage them and spend within your means.

Factor in treats.

In his book, The Barefoot Investor, Pape talks about the importance of “blow” and “smile” buckets. In other words, he suggests that you factor in allowances in your budget for things that you enjoy—dinners with friends, new shoes, or whatever puts pep in your step. Treats minimise a deprivation mentality and help us stay on course.

Accept that you’re playing the long game.

Economic transformation doesn’t happen overnight. It’s a long-term commitment. Once you understand this, you are more likely to meet your expectations.

Armed with this fresh awareness of money and human behaviour, I intend to make some changes in my own spending patterns this year—making sure I factor in plenty of treats! I wish you the prosperity and good fortune you might be seeking too.

Note: This post is in no way intended to replace the advice of a qualified financial advisor. Readers are encouraged to fully research their own financial decision making. Special thanks to my client Judy who has graciously allowed me to share her story with you.


Author: Lynne Woolfson
Image: Imgflip.com
Editor: Catherine Monkman
Copy Editor: Travis May
Social Editor: Travis May



Leave a Thoughtful Comment

Read 0 comments and reply

Top Contributors Latest

Lynne Woolfson