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Five tips to overcome cognitive biases and become a better saver

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Why is it we struggle to save for the long term, but we can easily eat out for the third time this week or buy the same dress in two colours that month?

A lot of us can put more significance on instant feelings of pleasure or wanting to avoid feelings of loss, when in reality we could be missing out on a bigger gain, a financial benefit that can impact our lives better.

We dive deep into two cognitive biases to understand why we financially behave the way we do and how this can negatively impact out financial future. We’ve included five tips to help us adopt better saving habits and to diminish emotional biases, like present bias and loss aversion bias.

We have a lot to get through, so let’s get started!

What is present bias?

Present bias is the tendency for an individual to give preference to rewards they can have now and attach more value to this rather than receiving the same/larger reward later in the future.  

When a person displays this behaviour they tend to choose a lesser reward now, rather than the more significant reward in the future. Present bias keeps an individual in the current moment and more attracted to the gratification and satisfaction of having the reward now, even if the person waited and could’ve had an even bigger reward in future.

For example, if you use credit cards or buy now, pay later schemes (BNPL), these methods of payment mean you can purchase the desired item now, say shoes! You can feel the pleasure of this purchase now, rather than holding the shoes in your saved items and waiting till your next pay day. When you have the funds there, you’ll feel a bigger reward for your patience and no added interest on top of the purchase.

Adopting the behaviours of a present bias can impact your bank account and financial future negatively. If you’re regularly using your money for reward, gratification and satisfaction in the present you could be missing out on the benefits growing your savings pot and earning interest.

What is loss aversion bias?

Loss aversion bias is a cognitive response where an individual tends to put greater emotion and meaning to losing something rather than gaining. A person will suffer more significantly than the joy that comes from gaining something, such as losing £5 to gaining £5.

If an individual displays these characteristics they’ll prefer to avoid any losses rather than thinking of the future gain.

Loss aversion can prevent people from making the best decisions of their lives, it can impact their life experience in finding a potential partner or going for their dream job, because the feeling of loss and the action is too risky. 

For example, a person is less likely to invest in stocks and shares as they see the potential loss is much greater than the gain they could benefit from. It can even be a struggle to put money away into a savings account or an ISA because they feel no instant benefit, just a loss of funds.

If you think you relate to these biases we’ve listed five tips to help overcome them and grow your savings pot and achieve a better financial future.

Consider your future self

Focus on yourself in five, 10 or even 30 years and visualise how you want your life to look. Whether it’s a beautiful house, a comfortable retirement or sending your grandchildren off to university, make a list! Projecting your present self into your future self will allow you to feel the emotions of gratification and satisfaction now. Taking each action and breaking them down into small steps can make it more manageable and digestible.

Automation and opt-in

Setting up automatic payments that come out of your current account on pay day and straight into your savings account is a great way to overcome loss aversion and present bias. Once you have the standing orders set up you don’t have to think about it or see it, there is no physical handover needed so no loss is felt. You may even forget you’ve set up these payments and return to your savings pot a few months later and see a lovely, healthy nest has built up!

Pay yourself first

We’re sure you’ve heard of the common phrase ‘pay yourself first’ and this is an important tip to remember as you are prioritising your long-term financial goals and wellbeing rather than focusing on immediate purchases, you’re paying your future self for a more stable and secure financial future.

Create an initial budget and take a percentage of that, for example, 10% and set up a standing order that will go directly to yourself. If you have multiple savings accounts set up, appoint one as a ‘fun pot’ or to use for a short-term savings goal that can put you into the practice of saving. This will hopefully help you realise that the feeling of loss you previously felt will diminish as you see your account grow.

‘Round-up’ savings

Round-up savings are a feature that’s offered by some financial providers in an effort to help customers save more. Each time a customer uses their card for a transaction the total amount is rounded up to the nearest pound and the change is allocated into a savings pot which you can choose initially when setting up the feature.

Think of this like putting all your loose change into a jar, especially when cash was the prominent method of payment. It’s a digital change jar and with practice, overtime can really build up. If you are still favouring behaviours associated with present bias this means that with the purchases you make you are still saving!

Technology is your best friend!

Setting reminders and turning on your bank notifications can play a helpful part in overcoming your savings struggles. Most financial services will alert you when money has come out of your bank account and send comparison messages on how much you’ve spent compared to the previous month.

Having these reminders can help you stay on track; you may feel the satisfaction when carrying the new item out of the shop, however, when your phone pings that feeling of loss can start to set in. This feeling of guilt from spending and acting on wanting an immediate reward can simply be helped by remembering your future self from our first tip.

Paragon Bank PLC is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England number 05390593. Registered office 51 Homer Road, Solihull, West Midlands B91 3QJ. Paragon Bank PLC is registered on the Financial Services Register under the firm reference number 604551