How do we slip into habits, for better or for worse? Over a decade ago, Massachusetts Institute of Technology researchers discovered that neurons weigh costs and benefits of actions, which drives habit formation. In The Power of Habit, Charles Duhigg explained it further: the mechanism is a neurological loop of cue (the automatic trigger for the behaviour), routine and reward.
If we understand this habit loop, we are able to set up effective new habits – or replace bad habits with better ones. Cue and reward are the levers. Duhigg gives this example: to establish a running habit, researchers showed that putting your running shoes next to your bed (cue) and eating a piece of chocolate (reward) after a run worked well.
Analysing the cue-routine-reward loop could help break unwanted spending habits. Take out-of-control online shopping. If boredom (the cue) pushes you online, set up an alternative cue: if I feel bored (and inclined to “solve” this by clicking on an online shopping site), then I will message a friend instead.
But could we apply this loop to one of the biggest money problems in our country? (It’s this: very few people save enough money to retire comfortably, where “comfortable” is a pension of about 70% of one’s final salary.).
The trouble here is that the reward – the opportunity to spend retirement savings – is often too distant. Our “present bias” means we prioritise immediate gratification over future rewards – choosing a low (or no) savings rate so we have more money right now. And saving for later can feel like an expense or even a loss. You could make a point of checking the growth of your savings (your reward), but that might not work well, as the benefits are usually seen in the long term.
Behavioural economists Richard Thaler and Shlomo Benartzi wrestled with the problem of under-saving for retirement. Besides “present bias”, they also identified lack of willpower and procrastination as obstacles, citing research on self-reported under-savers: 35% intended to increase their savings rate, but 86% of these “well-intended savers” had made no changes four months later.
They came up with a solution based on behavioural economics and psychological principles. The idea, which they termed “Save More Tomorrow”, is that they got employees to commit to increasing their savings rate at their next salary adjustment. And in practice, this idea worked well: in the first test run, participants increased their savings rate from 3.5% to 13.6% over 40 months.
Could you implement this? At your next salary increase – say it’s 4% – commit to using that, or a portion of it, to contribute more to your pension fund. That way, you don’t feel the “loss”. And go a step further: make a financial planning appointment to get insights tailored to your exact circumstances. As Thaler and Benartzi say, “determining the appropriate savings rate is difficult, even for someone with economics training”. Also, read the post on working out your financial freedom number.
