Many of us have read tips on saving, creating budgets, and understanding the importance of investing. However, when the end of the month arrives, our savings balances haven't increased or can even be depleted by simply "a little but often." What's going on?
Behavioral finance explains that humans don't always act rationally when managing money. Instead, we're easily influenced by impulses, our environment, our mindsets, and our old habits. For example, when there's a big discount or a "buy now, pay later" promotion, we can be tempted to buy things we don't need. Logically, we already know that it's better to save or allocate funds for long-term needs.
Loss Aversion
One common bias is where the perceived loss outweighs the satisfaction of choosing a better alternative. In the context of personal finance, this can translate into: we're reluctant to delay current gratification (e.g., buying a dream item) for fear of "missing out," even though we know saving is the wiser move.
Present Bias
is the tendency to place greater weight on current pleasures or needs than long-term benefits.
When friends or social media show off "cool" lifestyles, we can feel compelled to follow suit for fear of being left behind. So how can we stop this wasteful habit and actually save consistently? Here are some steps based on an understanding of behavioral finance:
First, create a "distance" between desire and action. For example, postpone an impulsive purchase for 24 hours. This will give you time to reconsider and evaluate whether the item is truly needed or just a fleeting desire.
Second, utilize technology to "assist" good habits: activate the auto-transfer feature to savings or investments every time your paycheck comes in, so saving becomes automatic.
Third, understand your financial environment: reduce exposure to advertisements or content that trigger consumer desires, and shift your attention to communities or content that support healthy financial habits.
Fourth, create written and visual commitments: for example, write down your long-term financial goals (vacation, house, retirement) and display images of them as reminders to re-evaluate every expense within the context of those goals.
With a behavioral finance approach, we can begin to see that wastefulness isn't simply due to "ignorance," but rather to the habits, psychology, and environment that drive it.
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