Psychology of Money: The Last Mile of Saving
41 Comments- Get free updates of new posts here
A few weeks ago, while I was at a conference in DC, I was attending a panel on email marketing when someone raised their hand and asked a question about advertisers and CPM vs. CPA. If you’ve ever been to a tech conference and waited for the Q&A period, this is about when you start contemplating different ways to commit suicide, including turning the conference program into a shiv to stick in your heart. People’s questions are that bad.
But this one was good. Very good. After the panel, I walked over to meet the questioner, and I realized we’d been emailing for a year. Amanda Steinberg is the founder of Dailyworth, a newsletter targeted at women and personal finance. Yes, women and money are different than men. So it was refreshing to see someone openly acknowledging that and writing targeted material for them.
I asked Amanda and her partner, MP Dunleavey, to write up a post on how we make a large cognitive error in our savings strategy. We’ll go through the enormous cognitive process of refraining from buying something, or negotiating a fee away…and then fail the last mile.
Today, MP shows us how to complete that last mile — and lock in our savings.
* * *
The Psychology of Money: The Last Mile of Saving
By MP Dunleavey, editorial director of DailyWorth
DailyWorth is a daily email about finance (the perfect supplement to iwillteachyoutoberich) for women delivering practical tips on self worth, net worth and everything in-between.
So you’ve cut back your car insurance, negotiated a lower interest rate on your credit card—or nabbed a great deal on a new TV. You’re congratulating yourself for being a smart saver, and keeping more of your hard-earned money in your pocket.
Not so fast. You haven’t actually saved any money…until you’ve put the actual cash in the bank.
You might say, “Well, duh.” But Peter Tufano, professor of consumer finance at Harvard Business School, says that many people confuse a lowered rate (on car insurance), or getting a discount (25% off a TV) with saving money. “It’s not savings until you save it,” he says.
You Need to Turn the Numbers Into Real Cash
Sounds easy, but it’s not. Making sure that mental savings morphs into tangible cash in your account is one area where your brain isn’t your best financial friend. You can thank a psychological phenomenon that economists have dubbed malleable mental accounting.”
Mental accounting stands in contrast to real-life number-crunching. If you transfer $100 from checking to saving, for example, there are clear-cut steps you have to take, from logging onto your accounts, selecting the transfer option, filling in the fields, etc.
How Your Brain Manages Money
Your brain takes a more flexible, sometimes freewheeling approach. Imagine that you just bought a TV on sale, marked down from $900 to $800. Or let’s say that you negotiated $100 off your car insurance premium. Your brain now believes it has $100 to play with:
“Hmm, I just saved $100. Score! That means I can spend a little extra on Jack’s bachelor party next week. Or, I could sock it away into savings. Actually, I think I’ll make an extra payment toward my credit card. Of course, Jill’s birthday is coming up…”
In reality, the money you’ve “saved” on the TV or premium is still theoretical. At this stage, because of the fuzzy nature of mental accounting—and because any reduction in price or fee simply means you’re paying less, not saving more—action is required to transform this into savings.
Take These Steps to Make Savings Happen
At this point you need to take three steps:
- Decide how you want to handle the “savings”: as one-time or a recurring event.
- Decide how much you can save and when, then set up reminders, if necessary.
- Choose where you plan to save it, based on your goals.
Don’t Talk Yourself Out of Saving
If you saved $100 off the purchase of a TV or 25% off a pair of shoes, aim to save some or all of that gain. This may require a negotiation.
First, you might argue that you bought the item at a discount because that put it within your price range. You never would have paid full price, so you don’t have extra to save.
Nice try. Studies show that most people have a range in mind when they spend. You got the TV for $800, but you were probably willing to pay up to $850.
Let’s say you go for the big gain of $100; it’s a single purchase, so you’re going to handle it as a one-time event. How will you turn this into real savings?
The last step is to look toward your goals. You can make a transfer to a savings account (personal, emergency, wedding, travel), put it toward debt (e.g. credit card, student loan, mortgage, etc.), or add it to your retirement account.
Two Ways to Save A Recurring Amount
If you negotiate a $25 reduction in your cell phone bill, say, the process is similar.
Beware of sneaky mental accounting: It’s tempting to believe that your bill has been lowered, so now you don’t have to do anything. Left to its own devices, that $25 will sit in your checking account and GROW.
Sorry. If you’ve “saved” $25 on a monthly bill, either add that amount to your automatic savings transfers each month—or be bold and add it up for the year ($25 X 12 = $300) and transfer that lump sum toward one of your goals.
Once you’ve taken action, and the actual cash is building up, now you can sit back and congratulate yourself, maybe even brag a bit. Not only did you nail some savings, you went ahead and saved it.
DailyWorth is a daily email about finance for women (the perfect supplement to iwillteachyoutoberich) delivering practical tips on self worth, net worth and everything in-between. Sign up for DailyWorth here.
Join my FREE Private List on overcoming psychological barriers and living a rich life
Hardly anyone in the personal finance space talks about the psychology of money (barriers, invisible scripts, etc.) Yet, as you can see, these are some of the most powerful forces behind our decisions. If you want more tips like these, I’d love if you joined my FREE Private List.
Each week, I’ll send you:
- Ways to overcome psychological barriers that hold you back
- How to use systems and automation to grow your money on a schedule
- Ways to earn more money using skills you already have
- Much, much more
You can join for free by signing up below:
One of the things I love about Shark Tank is the brutal honesty that entrepreneurs get. Shark Tank is the ...Read More