Like with any good habit, the key to consistently saving money is to become addicted to it.
If you find it hard to save money, you’re not alone. A JobsCentral survey covering over 3,000 salaried workers found that about 60% of Singaporeans save less than one-fifth of their monthly wages - the minimum required to adequately meet retirement and future financial needs, according to financial experts.
Singapore’s standard of living may be high, but we also command among the highest average salaries in the Asia Pacific. So why do the majority of Singaporeans fail to save enough money?
It turns out that those who struggle to save money may be grappling with the effects of a pair of cognitive biases - Time Discounting and Mental Accounting - that conspire to make money stray from their bank accounts.
Time Discounting Makes You Spend On Impulse
Recall the last time you splurged for overpriced coffee at your favourite coffee chain. You probably spent without thinking about it, the only thought in your mind being “Mmmm coffee. With double pumps of caramel syrup. And whipped cream. And sprinkles on top. And I want it NOW!”
But just as you head for the door, you get a notification on your coffee store app about a 50% discount at a new outlet. However, the new store is only opening in a week’s time. What would you do? Proceed today and pay full price, or wait one week and pay half price?
When you fail to stop yourself from spending money on something you don’t need, what you’ve really failed to do is to delay gratification. But don’t feel too badly about not being able to help yourself, because it is time discounting at work.
Time discounting is described as the tendency to ascribe lesser value to a reward the further it is from the present moment. In experiments illustrating this cognitive bias, participants were given the choice to have S$100 now or S$1,000 in the future. Which reward they picked depended on how long they had to wait for the S$1,000.
If the S$1,000 was just one month away, most participants chose to wait it out in order to get the higher reward. If the S$1,000 was, say, 1 year away, most participants chose to take the S$100 today.
Notice that the objective value of the rewards had not changed, only the waiting period. Hence, what we know and experience as impulsive buying is really just our cognitive bias making future rewards seem less enjoyable - even if the future reward is much more valuable.
That is why we rather buy what we want today, rather than waiting till we are in the right financial state to make the purchase.
How to Manage Time Discounting
So how do you go about finally saving money, for real? You need to get addicted to saving money, by making the habit satisfying and rewarding for you.
To manage the ill effects of time discounting, you need to put the brakes on impulse spending. You can do this by trading the immediate gratification of spending money now for the satisfaction of saving up money for the future.
Try this strategy: Every time you want to spend on impulse (coffee, shoes, snacks, etc.) take one-fifth of the amount you would have spent and put it aside. That’s your impulse fund.
Tell yourself you will let yourself have your indulgence only when your impulse fund allows it. If you follow the one-fifth rule, you’ll be able to have your expensive cuppa after denying yourself only four times.
This way, you’ll be saving money, cutting down your unnecessary expenses by 80%, while still indulging in your favourite treat every so often. More importantly, you’re building up the ability to delay gratification, a trait found in many successful people.
Mental Accounting Makes You Spend Your Bonus
Say you decided to buy a laptop for S$1,200. When you got to the store, the only set left is a refurbished unit that only had its outer casing replaced. Everything else is brand new and the laptop is working perfectly, and still under warranty.
The shopkeeper decides to give you a discount of S$300 to entice you to take the set off his hands. You agree, walking away with the laptop and S$300 savings, correct?
Not quite. What had happened was that you spent less on your purchase. You haven’t really saved S$300 at this point. Without this distinction, your brain is apt to treat the discount as money to be spent.
This is due to mental accounting, a cognitive bias that makes us use money in one account differently than money in another account. Essentially, the source of the money affects how it is used. This is irrational because a dollar is a dollar, whether it is in your pocket or in your stock options.
However, think about the last time you received an unexpected sum of money, such as a tax refund, birthday money, or even your bonus salary. Chances are, you spent the money on something you didn’t really need.
This behaviour is also readily seen when considering CPFIS investments, on which many Singaporeans lost money last year. If those same Singaporeans were asked to invest several thousands from their savings accounts (which is likely top of mind), instead of their CPF monies (which most people don’t pay as much attention to), they are much more likely to think twice.
How to Deal With Mental Accounting
So how do we deal with mental accounting? By being ruthless. Any discounts that you get must be physically moved into your savings account. Only then can you be sure that the S$300 savings you got from your laptop purchase is truly saved up.
You can do this with your credit cards too, by moving any amount you get from cashback, rebates or discounts into your savings account.
(If you don’t have a separate savings account, we strongly recommend you set one up. Don’t apply for an ATM or debit card for this account, however - you want to make it easy to put money into it, but not so easy to get money out.
When your savings account is not so easily accessible, it’ll soon fade into the background of your consciousness. You’ve just made mental accounting work for you!)
Let the Magic Happen
Once you get into the groove of things, staving off impulse buys, building up good habits and enjoying small treats occasionally, your savings will start to grow in a meaningful way. And that’s when the magic happens.
Soon, your bank statement will reflect a figure that’s going to get you excited, because you’ll be able to afford that cute backpack, that stylish jacket, a holiday to your favourite country - or whatever that hits your sweet spot.
At this point, you may decide to splurge on yourself as a reward for achieving a milestone - hey, you succeed in saving up money! If you want to do that, go right ahead.
Or, you may find a curious thing happening. Knowing that now you can buy yourself that new jacket anytime you want, you feel just as happy without it.
Why is that? Because it’s not the actual buying of things that make us happy. Rather, happiness stems from the freedom to buy things.
So, recognise and deal with the ill effects of Time Discounting and Mental Accounting, give your bank account time to work its magic, and you’ll soon be saving up money like a champ.
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How to Save for Retirement if You Started Saving Late
By Alevin Chan
A Certified Financial Planner with a curiosity about what makes people tick, Alevin's mission is to help readers understand the psychology of money. He's also on an ongoing quest to optimize happiness and enjoyment in his life.