IMAGINE YOU’RE on a gurney, head immobilized, being rolled into an fMRI, a functional magnetic resonance imaging machine. Initially, as the machine clicks, pings and hums loudly around you, you’re instructed to think of nothing in particular. But then the work begins. Pictures flash on a mirrored panel in the closed tube. They’re crude, almost like early PowerPoint presentations. The first shows a small reward that you can have right now. The second shows a larger reward, but you have to wait until tomorrow. You’re told to choose between them and indicate your preference on a small clicker placed next to your dominant hand. The pictures continue. There might be bigger rewards. Longer delays. Other scenarios.
That’s been the scene not in hospitals but in labs at Stanford, Carnegie Mellon and other universities as neuroeconomists try to get a grip on why we make -certain choices about money. This research has been particularly enlightening when it comes to why we’re so bad at putting money away. The savings rate in America is 5.5 percent, only about half of what experts believe it needs to be. The fMRI scans show us the reason: We prefer immediate gratification to delayed gratification. Some researchers have found that when we see what we want and get it quickly, there’s a lot of pleasurable brain activity. When we consider something for consumption later, the pleasure centers of the brain react less intensely.
So how do you get yourself to save more? Mind games. You can play tricks on yourself either to feel better about saving and therefore want to do it or to simply do it anyway. Here’s how to get yourself to spend less and save more.
MAKE IT REALLY UNPLEASANT TO MISS YOUR FINANCIAL GOALS
In 2007, after struggling to lose 25 pounds for more years than he wanted to count, Yale professor Ian Ayres put his money where his mouth was. He challenged himself to lose a pound a week and, when he lost 25 pounds, to keep the weight off for three years. He’d weigh in once a week and choose people to monitor his progress, and for each week he failed, he’d cough up $500 to a friend to give to charity. Ayres succeeded—and has conducted research that shows how a similar approach can help you save money.
Incentives like this work, he says, largely because of loss aversion, a principle of behavioral finance that essentially means we humans will go to greater lengths to avoid losing money than we will to gain an equal amount. “Losses loom large,” says Ayres, who wrote a book on the subject called Carrots and Sticks. “People will work really hard to avoid them.” In fact, people who make good use of incentives are three times as likely to reach their goals as those who don’t.
How do you put an incentive program into play? Let’s say your goal is to save 10 percent of each paycheck. You need to come up with a penalty that makes missing that mark both expensive and uncomfortable. (Ayres believes he lost the weight precisely because the price was so high. Weight Watchers, he points out, costs about $500 a year, not a week.) To compel yourself to save, he suggests committing to give away 10 percent of your disposable income if you fail: “You’ll feel the pinch, but you’ll still be able to pay the rent.”
Choosing a charity to receive the money if you fall short is equally important. “Picking one you would support anyway is not a very effective commitment device,” he says. (Some experts suggest you should send the money to
a group whose cause you despise, like the NRA if you support gun control.) And then there’s the choice of your hall monitors. “They shouldn’t be people who love you too much,” he says. “The problem with unconditional love is that it has an enabling quality. Instead, pick your boss, a colleague, an acquaintance who will hold you accountable.” Stickk.com, a website started by Ayres and two Yale colleagues, can help you put these ideas into practice. After signing a “commitment contract,” you set the stakes and choose a referee; you can also enlist friends to cheer you on.
LOCK AWAY YOUR MONEY
Loss aversion is also a key reason that 401(k) plans and IRAs are effective savings vehicles. If you pull your money out before age 59½, you pay for it big time: income taxes atop a 10 percent penalty that, combined, can cost you 30 or 40 cents for every dollar.
Unfortunately, IRA contributions are capped at $5,000 a year until you hit age 50, and $6,000 thereafter. And even if you’re maxing out your 401(k) contributions, you may need more to retire comfortably. “Look for places where it’s expensive—or a hassle—to get your money out,” says Brigitte Madrian, an economics professor at Harvard. Pricey parking places include college savings accounts, health savings accounts, bank accounts that charge a monthly fee if your balance falls below a particular level and CDs with a penalty for early withdrawal. Internet banks that don’t have an ATM presence also make sense because it can take several days to access your cash.
FACE YOURSELF AT 65
In the Virtual Human Interactive Lab at Stanford, people in their twenties and thirties are being introduced to their future selves—or, rather, to avatars that look and move like those young people might 30 or 40 years in the future. After playing with their avatars, testers are asked a series of questions about how much money they plan to save. Those whose avatars are in their midsixties say they’ll save 30 percent more than those whose avatars aren’t aged at all.
Why the jump? “The biggest obstacle in saving for retirement for a 35-year-old is that it’s 30 years in the future,” says David Laibson, a Harvard economist. Try to think about yourself 30 years from now. You don’t know who you’ll be, where you’ll live, what you’ll need—let alone what you’ll want. You’re little more than a stranger. And that can push saving for your future well-being down to the bottom of the priority list. But when you see your- self at that age, the need to protect yourself becomes more real.
Financial institutions are already considering the avatar-aging technology as a way to boost deposits, says Jeremy Bailenson, author of Infinite Reality and head of the lab at Stanford. “You’ll upload a photograph, and the bank or brokerage will take care of the rest, showing you your future self being sad or happy depending on how much you’re saving. When you go to your bank and you’re deciding how much of your paycheck you want to spend, it will have a real effect on you.”
Until that happens, you can try to replicate the result on your own. Unfortunately, Bailenson says looking at a picture of your mother (even if she’s a dead ringer) probably won’t do the trick. You need to see you, older. You can purchase an aged picture of yourself at age-me.com starting at $3.99.
VISUALIZE WHAT YOU’RE SAVING FOR
Columbia Business School professor Sheena Iyengar, author of The Art of Choosing, recently conducted a study at some 401(k)-plan enrollment meetings for clients of ING. She added a question to the standard form that asked participants to imagine the benefits of saving more money. That simple exercise made a significant difference: Nearly 25 percent more of the participants who did it chose to increase their savings compared with those who didn’t.
You can get yourself to do the same by picturing the long-term results of upping your savings. Be specific, Iyengar urges. Think about what your dream retirement house looks like and what kind of car you’ll be driving. Do you see yourself maybe living or vacationing in a tropical paradise? Cut out a picture of your ideal home (with a swimming pool? a view of the ocean?) and carry it in your wallet, or download one and make it your screen saver. Then, while you’re still in the moment, call your benefits department and increase your 401(k) contribution or contact your bank and sign up for a monthly transfer of funds out of checking and into your hands-off savings account.
SET UP SUBACCOUNTS FOR
Behavioral finance has also identified poor mental accounting as another reason people tend to undersave, says Madrian. Here’s how this one works: You probably have several long-term goals—college tuition for your kids, new living room furniture, a more fuel-efficient car, a beach vacation. You probably also save for many of those things in a single account. But having all the money in the same place can lead you to mentally overspend it. “You save $1, and you think, I’ve saved $1 extra for my vacation, $1 toward my car, $1 for furnishing the living room,” Madrian says. “But you haven’t saved $3 at all; you’ve saved $1.”
To fight this tendency, set up a system in which the money is earmarked. That means a college account, plus a vacation account, plus an emergency savings account. (Note: Keeping them all at the same bank should eliminate paying too much in fees; most banks now require you to keep a minimum deposit in all your accounts combined.) “This helps you realize how much you need to save for each particular goal,” Madrian says. (Don’t feel too bad about this misunderstanding. She notes that our government does it all the time: “When tax revenue goes up, the government thinks it can spend on schools and roads and health care.”)
DON’T DECIDE; AUTOMATE
As far as effective strategies go, the one with the most data behind it is setting up automatic transfers into your savings accounts. Here’s a bit of proof that it works: Nearly half of all 401(k) plans now automatically enroll their employees. At companies that auto-enroll, 80 to 90 percent of employees are in the plan, twice as many as in companies that don’t auto-enroll. And families with some kind of retirement plan have an average net worth of $860,000, nearly four times the average net worth of families without one.
If you work for a company that doesn’t offer a 401(k), you can fashion one for yourself. First, set up monthly automatic transfers into your retirement, college and savings accounts. Second, pick a date once a year when you’ll increase these amounts. And if you need a further push, make an appointment to do the paperwork with someone you trust financially. “Use the meeting as a disciplining device to get it done,” says Laibson, who also suggests giving yourself a deadline. He published research on a firm that told employees it needed to know within a month whether they would be signing up for the retirement plan. “Just doing that increased participation from 40 percent to 70 percent.”
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