If all the psychological talk lately has your mind racing, you’re going to love this one.  Did you know that most folks that have trouble saving are affected by two “cognitive biases”?  Not a fan of $5 words?  Think of a “cognitive bias” as a bad behavior our brain is pre-configured to do.

This all comes from an article in The Atlantic (read here). The two biases that affect our savings abilities are “present bias” and “exponential-growth bias”.  And before you go grab a psychology textbook, hang on.  Here’s a quick description of what each one means.

Present bias is the idea that we’re all willing to agree to take on new behaviors and display better self control provided we don’t have to do it immediately.  Every New Year’s resolution, every in-the-chair promise to your dentist that you’ll start flossing and every January promise to your wife that, yes, this is the year the lights will come off of the house before Easter.  All of them are examples of present bias.  And this also displays why we naturally have trouble saving – the human mind struggles with the idea that $144 two years from now is better than $100 tomorrow.

Exponential-growth bias is a tougher bias to explain (and say!).  But basically, it boils down to humans struggling with true comprehension of some of the higher math used in figuring out and determining the value of saving money.  Things like how compound interest actually works.  According to one study cited in the article, 75% of the participants did not truly and fully understand compound interest.

So what do we do about these biases? Well, we all have them and the issue isn’t what we do with them. It’s what others do. The author suggests the bigger issue isn’t that we have these inherent biases, it’s that companies know about them and actively use them against us.  As the article calls it, these companies are nudging folks into being bad savers.

For instance, we are all part of the 401(k) generation.  Very few of us have pensions.  Now, how many of you out there have employers that match your 401(k), or feel that you received adequate instruction on how to invest within it?  Compare how much you’re told about increasing your contribution vs. all the ways you’re able to draw on it.  Look at the credit card companies – how large of a balance are you allowed to carry compared to your minimum monthly payment?  If you’re not careful, or even if you’re careful but passive, you’ll end up with a balance that you’ll never pay off, as you’re inadvertently nudged into bad behaviors.

If this raises concerns, or questions or you feel like maybe you’d like someone to watch your back, give us a call at 215-657-9200. Or just email us at [email protected].