Do you spend the cash in your wallet on a splurge item, even though you know you should save it? You wouldn’t be alone — plenty of people struggle to set aside cash for a rainy day when something shiny in the here and now beckons.
When you decide to splurge, you (along with countless others) experience a phenomenon called “present bias.”
What is Present Bias?
Present bias refers to a cognitive tendency that convinces people to choose immediate rewards over future benefits — even if the future gains promise a bigger prize.
In other words, it values instant gratification over delayed gratification.
This quirk of human psychology can interfere with your ability to make sound financial decisions. After all, your financial security is based on how well you can save for a faraway purchase or experience, like an unexpected expense or retirement. You can save up for these goals properly if you constantly chase after immediate thrills.
Everyday Examples of Present Bias in Your Life
When it comes to present bias in your finances, it can manifest in many different ways. Here are three of them below.
Example #1: The Spend Now, Worry Later Shopping Spree
Let’s face it—temptations to spend money are all around us. In today’s consumer-driven world, it’s easy to fall into the trap of swiping our credit cards for that instant gratification.
According to Yahoo News, 55% of people carry a credit card balance from month to month. A whopping 40% of these people haven’t been debt free since 2018.
Carrying a balance this long has consequences. Not only does itaffect your credit score and increase your debt-to-income ratio,but it also ties up this financial tool. You won’t be able to rely on it should an unexpected expense comes along.
When faced with unexpected expenses and limited savings, some individuals turn to online loans as a means to bridge the financial gap. Going online can simplify your search and speed up how quickly you can apply. These convenient benefits of an online loan can take some of the stress out of your emergency.
While these online loans can be helpful in emergencies, they should be seen as a backup option rather than a primary solution.
Example #2: Quick Wins vs Slow Saving
Most people collect debt over time — an online loan here, some credit card debt there, plus a mortgage, car financing, and student loans.
It all adds up; the average American household carries $101,915 in debt, according to the latest Experian data.
When it comes to paying off debt, two popular methods are the snowball and avalanche approaches.
The snowball method involves paying off smaller debts first, providing a sense of accomplishment and motivation. This approach is appealing as it aligns with our desire for quick wins and immediate progress.
However, the snowball method may not always be the most financially advantageous.
The avalanche method, on the other hand, focuses on tackling debts based on interest rates, prioritizing higher-interest debts first to save more money in the long term. This method requires discipline and a long-term perspective, which can be challenging for those influenced by present bias.
Example #3: Short-Term Gains vs. Long-Term Rewards
Now, let’s shift to investing. The stock market can be a roller coaster ride of emotions, with quick wins and sudden losses.
Short-term investment strategies may provide the thrill of immediate gains, such as day trading or chasing hot stock tips.However, they often come with higher risks and can lead to impulsive decisions driven by present bias.
By comparison, long-term investing options such as a diversified portfolio or retirement accounts won’t offer similar instant gains, but they have the potential to generate substantial wealth over time. This is how people manage to save the recommended $1 million for retirement.
By resisting the urge for immediate gains and focusing on long-term rewards, you can build a solid financial foundation that will serve you well in the future.
How Can You Squash Present Bias in Your Own Life?
Now that you know how present bias can wreak havoc on your finances, it’s time to learn what you can do to avoid it.
1. Set Clear Goals
Define your financial objectives and establish a clear roadmap. By envisioning the long-term benefits of saving, you’ll be motivated to overcome present bias and stay on track.
2. Automate Savings
Set up automatic transfers from your paycheck to a separate savings account. This way, you save without even thinking about it, which may prevent you from spending impulsively.
3. Create Accountability
Share your saving goals with a trusted friend or family member who can hold you accountable. Discuss your progress regularly and celebrate milestones together, reinforcing your commitment to long-term financial well-being.
Bottom Line: Practice Delayed Gratification
Present bias can be a significant roadblock on your path to financial success. By recognizing its influence on your decision-making process, you can take proactive steps to overcome it.
Remember, saving money is crucial for long-term financial stability. By setting clear goals, automating savings, creating accountability, and practicing delayed gratification, you’ll gradually shift your mindset and break free from the grasp of present bias.