The Neuroscientific Guide to Being Financially Responsible
We’re well past the halfway point of 2019. Like everyone else, you have made plenty of financial decisions so far; some good and some that are less so. You know the correct actions to take: build up your savings and avoid frivolous spending on short-term gratification. You know that, but then Friday rolls around and maybe you splurge a little more than you should on a nice dinner, or you see a new gadget that you simply must get your hands on.
This is normal. Neuroscience proves what we’ve all known: delaying gratification in the short-term to benefit oneself long-term sounds good to us on paper, but it’s much harder in practice. We’re here to explain why that is, and how you can trick yourself into being more financially responsible.
Why am I like this?
A study at Princeton University concluded that different kinds of decisions involve different areas of the brain. Short-term, instant gratification decisions are made by more emotional parts of your brain (such as the limbic system) whereas long-term, practical decisions are made by the more logical parts of your brain (like your prefrontal cortex). These two parts compete whenever you make a decision. For this reason, many of the financial choices we make involve some level of emotion.
To take this into account, there is a whole branch of economics called Behavioural Economics. This branch is dedicated to explaining why real-world market trends don’t always match the trends implied by the data available: there is a human, emotional element at play.
Checking your blind spots
A great start to avoiding the pitfalls of your emotional decision-making is knowing about them. Below are a couple of classic examples of behaviours we exhibit when thinking about money (although it’s by no means a complete list) and how to avoid them.
High Self-Rating: You might not want to hear it, but you’re probably not as smart as you think you are. Many of us tend to rank ourselves as smarter than the average person even though, statistically, it’s unlikely. So, when we make a financial decision that pans out well (like a risky investment that pays off) we attribute much of that success to our own brilliance. But, when our decision results in failure we’ll blame it on external factors, like the market performing poorly. The key to overcoming this is acknowledging that there’s always more for you to learn, and to research all your financial decisions as much as possible before taking the leap. If it doesn’t work out, self-evaluate your role in that loss happening.
Herd Behaviour: this is the tendency we have to mimic the financial decisions of those around us. Remember when cryptocurrency became wildly popular overnight, so everyone invested, and the value plummeted? That’s a great example of herd behaviour. Again, the key to avoiding this is to stop, take a breath and take time to research an opportunity for yourself, through reputable sources, before reaching a decision. Much like wearing shoulder pads in the 80s, you need to first ask yourself: is this actually a good idea or is it just popular right now?
Loss aversion: Losing sucks. That’s why you’re more likely to make a decision that avoids loss than one that potentially involves a gain. For example, you’re more likely to take financial action when a penalty such as added cost is imminent rather than when you might get a reward. You probably make sure to pay your credit card off on time, but you don’t jump to use every coupon available to you in various newspapers. Overcoming this means reshaping your priorities to be on the lookout for ways to save money. When you find yourself less motivated to undertake these methods, ask whether you would feel the same way if, instead of getting 10% off, you were adding 10% to the price.
Tricking yourself into saving
While it is useful to know about your natural biases and work against them, self-control is still really hard. Research has shown that, in fact, the best way to exercise self-control is to take the “self” out of the equation as much as possible. What this means is you need to remove yourself from situations where you may be called upon to make a potentially costly snap financial decision.
What does this look like? Well, make sure you have automatic payments and savings contributions made at the beginning of each month (or even better, at the end of the preceding month). You don’t have to think about paying your bills or contributing to your savings because it’s already done. If you have trouble with budgeting and impulse buys, you can get a card with the exact amount of money you have allotted to yourself for a week on it. When the card is empty, your spending stops until the next week, when you recharge it with the same amount. This forces you to think a bit more carefully and plan your week-to-week spending. Sure, you can impulse-buy that new bag, but then you’re going to be eating two-minute noodles for dinner for the next five days.
You can also take yourself out of situations where you know you’re likely to overspend: don’t spend the weekends browsing the mall, avoid restaurants and suggest a pot-luck dinner at home instead, and obviously don’t hang out with your high-rolling, horse race betting friends. The less decision-making you have to do, the less likely you are to lose at it.
Another strategy to cultivate as a shopping skill is to delay as many of your purchase decisions as possible. There is evidence to suggest that waiting a few hours or sleeping on a decision will reduce the immediate brain reward for making a more emotional decision and will strengthen the decision-making systems of the higher frontal cortical regions. With delaying (‘sleeping on it’) over time, you will reduce the likelihood of making snap impulse buy decisions.
It’s about the journey
It’s important to remember that, much like weight loss, responsible financial habits take time to accumulate and are harder to maintain. It’s inevitable that you’ll make a mistake or do things you regret, but it’s important that you be patient with yourself and keep working towards your financial goals. We hope this helps.