Research by the Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) has revealed the biggest hurdles to managing our finances.
Simply having financial knowledge does not equal capability.
The researchers say it comes down to our behaviour — which is “often systematic and predictable” — to explain the way humans think and why we sometimes make decisions which run counter to our best financial interests.
The RSA says “effective financial capability is more than knowing about financial concepts, it is exhibiting behaviour which takes this knowledge into account” and that humans are in general, “wired for imprudence”.
Whilst paying bills and managing debt can be exhausting in itself, the RSA has identified six “behaviour hurdles” or human characteristics which set us back from being smart about our money.
Research has shown that making multiple decisions in a row, especially those under time pressure, can be mentally exhausting. Having fewer options is better because when people feel overloaded they tend to resort to the simplest answer. For example, people who report higher overload when making retirement decisions are more likely to select a simple annuity instead of a more complex retirement investment which would be likely to have a better return.
Having too much on your mind can impair decision making. When we’re in a “hot state” (hungry, tired, emotional, aroused or excited), we tend to make spur of the moment decisions such as spending too much which can undermine our ability to stick to a budget.
Optimism and overconfidence
“Optimism can lead people to underestimate the chance that they will be affected by a negative change in circumstance, and fail to plan accordingly,” the RSA says. As a result, people may be less inclined to protect their dependants or assets which could reduce their financial resilience.
Impulsive spending and the need for instant gratification can make it extremely difficult for people to maintain a budget. Research shows there is a tendency for people to choose small rewards sooner over larger rewards later which could prevent effective debt management and retirement savings.
“People who bought goods impulsively were three times more likely to go bankrupt, and four times more likely to run out of money by the end of the week,” says the RSA.
When a behaviour becomes a habit, this is often carried out mindlessly due to a lack of reflection. When these habits are bad, they can challenge financial capability because they recur and are more costly. For example, payment by card does not trigger the “pain of paying” that is experienced when paying with cash.
Influence of social norms
Social norms and the people around us can have a huge impact on behaviour, especially with money management. While it is not necessarily harmful, it can spur others to spend more or limit peoples’ ability to maintain a budget.
“People are more likely to invest in the stock market if their neighbours do, buy insurance if others around them do, or make a particular investment if other investors do,” says the RSA.
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