You have two slips of paper, each with pictures of a piece of chocolate cake and an apple. On the first slip you must circle which of the two you want to eat right now, and on the second slip, which you want to eat next week. If you are like most people, you circled the cake to eat now and the fruit to eat next week. Why?
Understanding human psychology unlocks the secrets to why we do the things we do, and may help us recognize why we may not always act in their own best interest. According to Dilip Soman, a Professor of Behavioural Economics at the University of Toronto, many Canadians are reluctant to practise good financial habits because, quite simply, “Consumption is sexier than saving."
“It’s exciting to buy, it’s exciting to eat, it’s exciting to watch movies. It is not as exciting to buy insurance or balance your cheque book or education account,” explains Soman.
He believes our senses control much of what we do and how we spend our money, saying things we can touch, taste and smell drive decision making.
“I know I shouldn’t be eating this fancy dessert and instead putting the ten bucks away in my retirement account,” he offers by way of explanation, “but if I’m walking past a cake shop and I can smell the darn thing, I’m going to take it.”
Other behavioural concepts that may be holding us back are a little less obvious. For example, when offered two similar rewards, humans show a preference for the one that arrives sooner rather than later, and often discount the value of the later reward, depending on the length of the delay.
Also, Soman says, “Things look very rosy in the future because we tend to think about the same act differently in terms of when it is going to happen.” To illustrate the point, he asked a group to write down what it means to construct a retirement savings plan in the future.
“People say I am securing my future and making sure my children are protected,” Soman explains. “But if you tell people they are to work on this tomorrow, they will say [they are], ‘Doing research in terms of which is the best investment, calling an advisor or opening a bank account.’”
Because long-term activities require more cognitive resources, Soman suggests we often put off doing such things, believing we will have more time to do them tomorrow. He also believes that the lack of adequate financial literacy may be holding back some Canadians. “When you decide to say no to the chocolate cake, what are you going to do with the ten bucks? It’s one thing to just stash it away in the bank but I think long-term financial well-being requires more expertise.”
Even so, Soman admits, “People who don’t save as much as they should know they don’t save as much as they should.”
For more on the psychology of money, read Conquer your fear of missing out to get on top of your finances, Are Your Childhood Memories Shaping Your Adult Financial Behaviour?, and watch Women and financial self-confidence.