Personal finance is not about more willpower
March 28th, 2009 - 22 Comments
Note: The bottom of this post includes a link to the most detailed public description of my own personal-finance system that I’ve ever done.
How often have you heard this?
- “If I just try harder, I should be able to save more money…”
- “Yeah, I know I should max out my 401(k)…”
- “I know, I spent way too much last month. I’m not going out at all this month”
Each of these makes me want to buy a cartoonishly large magnifying glass, lie under it on a sunny day, and calmly light myself on fire.
If you think personal finance is about trying harder, ask yourself: How has that worked for you in the last month? The last year? Have you really saved more? Invested more?
The idea that personal finance is about willpower is based around the heroic idea that our willpower is the most centrally important driver in our lives. But social psychologists know that the situation around us is at least as important as our personality. For example:
- The Milgram Experiment showed that the situation, not personality, could cause random people to give terminal electric shocks to helpless participants
- The excellent 1973 study by Darley and Batson study constructed a situation in which seminar students, as they walked to give a talk on The Good Samaritan, walked past someone “sitting slumped in doorway, who moaned and coughed twice as they walked by.” In fact, some even walked directly over the person. The situation that the researchers created determined the behavior, not the participants’ personality (although personality does play a role in other research on helping)
- Any of Brian Wansink’s excellent studies on food and psychology. “To a person, people will swear they aren’t influenced by the size of a package or how much variety there is on a buffet or the fancy name on a can of beans, but they are,” Dr. Wansink said. “Every time.” We like to believe we are in control of what we eat and how much eat, but the truth is actually much more complicated — and often related to external factors like the menu engineering, portion size, or your waiter
People don’t like hearing that external factors are often more responsible for their actions than they themselves are. But it’s true, and I’ll write more about investor psychology, social influence, and persuasion in upcoming posts.
So, back to money. We all “know” managing our money is important. We say being financially responsible is a “value” of ours. But knowing and saying doesn’t make it so.
The structures around us matter.
The importance of automation: Do the right thing by default
Here’s an illustration of how you can use psychology against yourself to do the right thing.
You might have seen my recent guest post about passive barriers. The chart above shows how contribution rates to 401(k)s jumped after companies implemented something called “automatic enrollment,” where employees are automatically enrolled in their 401(k)s.
This was vastly more effective than educating people about the advantages of 401(k)s. In fact, in another study, 100% of employees who attended a financial seminar planned to begin contributing to their 401(k). Only 14% did.
First, get the structures right. Then you can work on your willpower, which will be much easier once you see $100/month automatically going into your savings account.
Now, I don’t want to pretend that managing your money won’t take any behavioral change. Of course it will. Even though you’ll be able to still spend extravagantly on the things you love (sometimes, even spending more), you’ll have to cut costs mercilessly on the things you don’t. That takes work, and if you think that automating your money alone is going to make you rich, you are a moron.
But automating your money is a big win, and it sets up an infrastructure for getting rich without forcing yourself to pay attention to the day-to-day minutiae of managing money.
I’ve written a guest post on my friend Tim Ferris’s blog (he’s the author of The Four Hour Workweek), which includes a detailed writeup of how I’ve automated my finances. Check out the automation tips and get your structures set up right.
Automate your finances here: The Psychology of Automation: Building a Bulletproof Personal-Finance System
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