Do you find that you just can’t seem to save money even with a decent salary? The bad news: You make irrational financial decisions sometimes. The good news: You’re human, there’s a completely logical reason for why this happens, and there’s a simple solution.
Many economic models are based on the idea that we’re perfectly rational individuals who always make the best choices, but research (and life in general) shows otherwise. Sometimes we make errors of judgment because we take mental shortcuts.
One of these mental shortcuts is known as availability bias. The idea behind availability bias is that we tend to use the information that easily comes to mind when we make decisions.
Here’s a simple example of how availability bias can lead to bad financial decisions: Imagine Joey, an irrational human just like you, has $1000 in his chequing account. When he sees a a pair of shoes that cost $200, he decides to buy them. After all, he thinks, he has way more than that in his chequing account. Except that Joey isn’t looking at the whole picture. He’s looking at the balance in his account, but forgetting the fact that his $800 rent is due tomorrow.
Joey isn’t unique. Most people feel wealthier than they are when they have money in their bank account compared to when these funds are low. The credit card bill you have yet to receive and the phone bill that will arrive next month? They have much less impact on your decisions than the balance you see in your chequing account.
Luckily, there’s a simple way to prevent some of these irrational decisions that we’re hardwired to make. It’s called paying yourself first and the way it works is simple: Put some of your income aside every time you get paid. Paying yourself first can also be thought of as a method of systematically saving for the future.
Whether you decide to put the money in a savings account or an investment account is less important than the fact that you actually separate it from your day-to-day chequing account. If it’s not in your chequing account, it’s harder to access and you’ll have less temptation to spend it.
Paying yourself first allows you to build up your wealth consistently over time. It’s also a fantastic way to get your finances under control. Anyone who is receiving an income can adapt the method to their needs.
So how much should you put aside? That depends on your situation, including your income, expenses and debt. Experts generally recommend saving anywhere from 10% to 20% of what you earn. To make it easy, you can ask your employer or bank to make automatic deposits on every pay cheque. You can also automatically put money aside for the future by using Moka, which rounds up your everyday purchases and invests the spare change in a diversified portfolio.
However you choose to pay yourself first, the sooner you get started, the better prepared you will be for the future!