Avoiding Spending Is Not the Same as Saving Money

By Trent Last updated June 17, 2009

I’ve written often about the value of changing routines. Eliminating a routine that involves spending money needlessly, or substituting a different routine that involves spending less money, is a great way to cut your spending.

In fact, any time you make a choice to reduce your spending, you’re taking a powerful step in a financially healthy direction.

But it’s just a single step. Alone, reducing spending cannot bring about positive financial change in your life.

Let’s say that, much as I used to do, I visited a coffee shop each morning and spent $5 on coffee. I realized that this was something of a waste of my money, particularly given how I didn’t really enjoy each visit – it was just pure routine.

So I gave up that routine.

Suddenly, I’m spending $25 less a week – $100 less a month. That change in behavior made a big change in my money, right?

Not yet.

I could easily take that $25 a week and just do something else unnecessary with it. Since I have all of that free money now, why not buy an extra book or two at the bookstore once a week? Why not pick up a couple bottles of great dinner wine on Fridays? Why not go out to dinner on Saturday night?

After all, because I’m not spending as much, I have the money.

So I start spending that $25 a week on something else – and I’m right back where I started, just making ends meet.

Merely cutting your spending is not enough. You have to do something financially productive with that money.

So let’s rewind the clock. I make the choice to kick the coffee shop habit, trimming $25 a week from my spending.

Immediately, I set up an automatic transfer from my checking account to my savings account – $25 a week.

Then, at the end of each month, I scoop that saved $100 and put it towards my debt. Or I leave it alone and forget about it, knowing it’ll serve as an emergency fund. Or I start putting $100 a month into my Roth IRA. Or I keep adding more to it, saving up for a house down payment in a few years.

The first action – the one of avoiding spending – is powerful, indeed. It gives your finances breathing room. It frees up your money to be used for other things.

The second action, though, is the deal maker. When you choose to take that free money and put it towards something financially productive, that’s when real change begins to happen in your life.

Keep that in mind this week. Try to find one significant way to trim your spending. As you pass through the days, look for areas where you’re spending more than you should and not really getting value from your dollars.

If you figure out a thing or two, that’s great! But it’s just the first step. Go the rest of the way – figure out how much you save from that positive move, then invest that money in something financially positive in your life. Steer it into a debt overpayment. Put it into your emergency fund. Stick it into your 401(k) or a Roth IRA.

Do something. Move forward. Turn your positive personal action into a positive financial one.

Good luck.

http://www.thesimpledollar.com/avoiding-spending-is-not-the-same-as-saving-money/

The Psychology of Money – How Saving and Spending Habits are Programmed in Your BrainBy Suzanne Kearns

Have you ever wondered why you handle money the way you do? Perhaps you’re a saver and you feel satisfaction every time you look at your growing account balances and displeasure when you need to buy something. Or maybe you’re a compulsive shopaholic, looking at life as something to enjoy, so you buy on impulse and pay little attention to how you’ll survive in the future.While many people believe that money-handling habits come from parents or caregivers, current research is proving that our habits aren’t just based on conditioning and money management lessons we learned as kids. There are spenders and savers in the same families, kids who grew up in poverty and still develop great wealth, and heirs who blow the family fortune.If it’s not how you’re brought up, what does shape the way you view money? Experts are revealing that brain chemistry plays an enormous role in your financial habits.

Brain ActivityIn a study conducted by Rick, Cyder, and Loewenstein published in the Journal of Consumer Research, participants’ brains were scanned as they pretended to make buying decisions. Researchers observed activity in an area of the brain called the insula, which is stimulated when you experience something unpleasant. The more stimulation in the insula, the less likely you are to keep doing what you’re doing. When it comes to money, insula stimulation can stop your spending.On the other hand, the act of saving – either by having cash in a bank or by experiencing a significant savings on a product or service – brings savers intense pleasure. The victory of a good bargain makes everyone feel good, but savers feel the rush even more since it’s a relief from the discomfort of needing to spend.Meir Statman, a behavioral economist at Santa Clara University uses this analogy: If you go out to eat at a restaurant that typically charges $70 for a plate and you get your meal for only $7, it will taste better to you. But if you ate at that same restaurant without knowing the cost, you wouldn’t enjoy your food as much. Knowing the total amount saved gives savers immense pleasure.Researchers concluded that people who have more insula activity in their brains are more likely to be savers, and those with less tend to be spenders. And since we tend to skew to extremes, spenders can end up in financial trouble later in life, and savers can end up with great regrets. Recognizing which one you are can help you reach a healthier balance.

The SpendersIn an early experiment on children, commonly called the marshmallow experiment of the ’60s, researchers at Stanford presented nursery school children with a tray of goodies that contained marshmallows, pretzels, and cookies. Researchers told the kids to select one treat, and that if they ate it immediately, they wouldn’t receive any more, but if they waited only a few minutes, they’d receive another one. If they could delay their gratification for a few moments, they’d double their candy. They observed the children until they were adults and learned that the ones who were able to delay their gratification achieved much more success in life than the ones who wanted instant gratification.If you’re a spender, you can’t delay the gratification. With cash in front of you, just like the marshmallow, you can’t resist the urge to have it right now even if you’d have more later. That’s why you don’t have much savings in the bank, but it doesn’t bother you. You’ve been happy making purchases and enjoying them in the moment. It’s worked out well enough for long enough, so you just stick with the habit. But if you’ve realized that you’re trending toward extreme spending, then you’re probably looking to kick or curb your habit.These seven ways to calm your impulses will help you cut back on spending:

1. Never use credit cards or other lines of credit. By using cash, you force yourself to consider just how much you’re spending.

2. Withdraw cash from your bank account yourself, so that you can see the dwindling balance.3. Pay as you go. Don’t run a tab at a bar, and don’t pay everything up front for a romantic

weekend getaway. Pay for everything as it comes, and you’ll better understand how all that money just “gets away from you.”

4. Be vocal about your savings goals. If you tell close friends and family how much you intend to save and by what date, they’ll hold you accountable. You can even use personal goal setting tools like stickK to put money on the line to achieve your long-term financial goals.

5. Reward yourself when you meet your savings goals, but only by spending a responsible percentage of what you saved. This can help prevent frugal fatigue.

6. Stop and ask yourself before each and every purchase whether or not you truly need the item. Know the difference between needs and wants.

7. Look at the future, no matter how uncomfortable it is. Ask yourself questions like how much money you’ll need to retire, or how you’ll pay for your child’s college education.

The SaversIn another famous experiment, adults had the choice of receiving $50 immediately or waiting a year and receiving $100. Most participants surprised researchers by taking the $50. The instant gratification appeared more valuable than doubling the earnings after a delay. Savers are the rare ones who sacrifice plenty of gratification to make sure to get the full $100 when it’s available.Sometimes you’ll go without things that you really need, like good medical care through a health insurance policy or a warm coat, because money in the bank is more satisfying than anything you could ever buy. You rarely carry a credit card balance, and even on an average salary, you astound others with the huge nest egg that you’ve built up over the years, while they took just one marshmallow and the instant $50.

While many people take pleasure in buying things, savers don’t feel that same way. Instead, you’re uncomfortable with shopping, and you feel real emotional pain when you’re paying. But what makes you tick and brings you pleasure as a saver? Are you missing out on some of life’s simple, inexpensive joys? Are you sacrificing too much and endangering your health?Researchers explain that two primary motivators drive savers: pain and pleasure. And if you’re not experiencing enough pleasure, you deserve to loosen the pursestrings and enjoy spending just a little bit.

1. When it’s time for something pleasurable, like a vacation, distance yourself by paying with a credit card. You’ve already set your budget and you have the cash to cover it, so now you can take your mind off of the expense and relax.

2. Be vocal about your spending goals. When you’re planning to make an exciting purchase, even if it sounds like a boring necessity, tell everyone you know and set a date to close the deal.

3. Treat your purchases as a reward for something that you’ve done well, so they’ll take on more value in your mind.

4. Think of your future: Do you really want to have regrets over the things you didn’t do because you wouldn’t spend some money on enjoyment?

Final WordUltimately, we’re the ones who are in charge of our financial present and future. It seems odd to me that we’re driven by an aspect of our brains that we don’t even fully understand. But fortunately, this knowledge just might be what it takes to overcome our bad habits – whether that means excessive spending or frugality – and live our lives to the fullest, responsibly.What about you? Are you a spender or a saver? If you were given something you love, and told that if you hung onto it for an hour, you’d get double, could you do it? I’d love to start a discussion here and get to the bottom of this!

http://www.moneycrashers.com/psychology-of-money-saving-spending-habits/

Need to Beat Your Bad Money Habits? A Behavior Change Expert Explains HowBy Carolyn O’Hara.

As many of us know, bad spending and saving habits can often be notoriously hard to break.

Even when we want to save more for retirement or stop splurging on credit cards, our best intentions can get overtaken by impulses and old routines.

All of this comes as no surprise to behavioral finance experts, who make it their mission to study how psychology informs many of our less-than-rational money decisions.

That’s why we asked Dr. Hersh Shefrin, a pioneer in the study of behavioral economics and a professor at Santa Clara University’s Leavey School of Business, to explain how (and why) human behavior bucks economic logic—and to divulge the best strategies for overcoming those bad money habits.

LearnVest: What exactly do behavioral finance experts do?Dr. Hersh Shefrin: They study how psychology affects the financial decisions that people make, and the impact those decisions have on financial markets.

It’s a relatively new field. Around World War II, economists got it into their heads that economics needed to be more of a “real” science, like physics. They figured they could mathematize the psychological elements of finance and economics, put them into things called axioms, and determine outcomes by applying mathematical models.

But it wasn’t until the 1970s that psychology became something that serious economists studied when it came to trying to make sense of the economic and financial world. There were only a handful of us working in the field then. Then it took off like a rocket in the late 1990s and in the last five or six years since the financial crisis, it’s become especially hot.

What are some common ways in which human behavior can sabotage personal finances?

One is a bias to overweight the present and near future over the distant future, which leads us to not save enough for retirement, or to take on too much debt. A second bias is to be excessively optimistic, downplaying the extent to which bad things will happen. Of course, some people are excessively pessimistic, but within the general population, if there is a leaning, it’s in the direction of excessive optimism—leading people to think they don’t need life insurance, or that they aren’t at risk of crashes in the stock market.

There’s also confirmation bias—the tendency to turn off the hearing aid when someone tells you something you don’t want to hear and find inconvenient to change. So if someone says you shouldn’t carry such a high balance on a credit card, but you’ve done so for years and don’t feel it’s done you any harm, you won’t enact change.

Finally, there’s loss aversion—the tendency to experience a loss much more acutely than a gain of the same magnitude. That means when good things happen, we celebrate, but the things that really stick with us are the ones that went wrong. In fact, the average person experiences a loss two to three times more acutely than a gain of comparable magnitude. And that leads us to be shy about taking risks when it comes to money.

Why is changing undesirable financial behavior so difficult for most people?

Our brains are structured along multisystem lines. Most of what we think and do is automatic and below the conscious level, which is known as System 1, and the reasoning and conscious level is System 2. The part of our brain that’s engaged in conscious thought isn’t totally aware of what’s happening at the System 1 level, even though that’s where most of our brain activity is taking place.

The way most of us operate is that our System 1 finds stimulus response patterns that work and, in the process, we get good at habits through repetition. It’s like digging a groove. The more you

do it, the deeper the groove. And the deeper the groove, the harder it will be to get out.

So how can you overcome those patterns?

There is a great metaphor for understanding change. Your brain is like an elephant and its human rider. The elephant represents System 1, which is simple but powerful. He pulls the heavy load, but gets swayed by emotion. The rider represents System 2—the conscious, rational, deliberative part of you.

Since the rider is sitting on top of the elephant, he’s not going anywhere unless the elephant agrees. So you have to figure out how to motivate the elephant. If the elephant decides he’s just as happy sitting where he is now, there’s no hope.

You also need the foresight to understand what the path will be like to your destination because elephants get distracted. If you don’t understand what the obstacles will be and how to keep the elephant engaged, you’ll only get partway to your destination.

Does that suggest some financial behavior is hardwired in our brains?

Yes, some behavior really does stem from evolution. Loss aversion was well-suited to some past environment in which we lived. Same with confirmation bias. But our environments have changed more rapidly than our brains have adapted through mutations, so we’re stuck with old software in a new environment.

Think of it as if Microsoft created our brains. The thing about Microsoft is they’re not the most elegant group of engineers. They take their old software and add new features to it—and those new features are always buggy. But they don’t go back to ground zero; they always add on to what was there in the past.

That’s how our brains are built—on top of lizard brains. It’s old software, and nature is always adding to it, so we’re stuck with all

that stuff that was put there for a reason way back when, but we don’t necessarily need it now.

Can good financial behavior be taught?Nature and nurture are both important, but nature is huge. One particular gene is especially important for good financial decision-making—and less than 1 in 4 of us has the variant of the gene.

Parenting and education can counteract nature to some extent, but there are big “but”s. We know that most financial-literacy education efforts have failed. But there is one thing that seems to make a difference: exposing kids to a stock market game. If you let students play this game in which they actively invest, there are huge spillover effects to other types of financial skills.

The reason is because of the way our brains work—you need to activate reward centers within the brain so that people want to do things. Kids get excited when they are competitive. So we know it’s possible to make inroads with teaching better financial literacy, but we’re only beginning to understand what’s going on.

RELATED: 5 Secrets to Better Life HabitsDo certain strategies work better than others when trying to change financial behavior?

It’s typically very hard for many people to accomplish change by themselves—they need a program. So if you want to save more for retirement, for example, the kind of program that usually works has more than one step. But you want to make sure the program is voluntary—if people feel they’ll be locked in, they won’t want to start.

For example, step one can be to save through your employer, using a vehicle like a 401(k), so the money is automatically deposited for you. And step two can focus on taking additional savings increases out of pay raises, so that you don’t have to face smaller paychecks.

If your goal is to borrow less, step one is to find someone to help you structure a pay down plan. You also want to engage an ally that you respect to be your coach, so you can show them the progress you’re making—and who will make you feel embarrassed if you pull out. This way you have a built-in motivator who will make you think twice before you go off the plan.

RELATED: How Your Friends Can Help Your Finances: Create a Money Club

How does behavioral finance help us understand the financial crisis?

It tells us a lot about Wall Street and psychological pitfalls. The large financial institution UBS did a public mea culpa and released an analysis of the mistakes they made in the run-up to the financial crisis. Not only is it a very honest report, but it’s also a treasure trove for identifying the specific psychological pitfalls that afflicted decision makers.

For one, they were guilty of excessive optimism and overconfidence, which led them to underestimate the risks posed by financial instruments like credit default swaps. And confirmation bias helped blind them to information that challenged their view of the markets. So you can see just how pervasive and powerful these concepts are—and how dangerous they can be.

You’ve researched how financial professionals aren’t immune to psychological pitfalls. How so?

Most of us are overconfident about our abilities. It’s part of that old software legacy. It kills us to feel that we’re not above average, but half the population is below average.

For example, we know that there is far too much trading in the stock market. Part of the reason why? If you think you are above average, then you also think you can get in there and win. And if you think you can win, you trade actively. But if you trade

passively, it’s like admitting you are no better than average. So this is something that is going to afflict professionals, as well as regular people.

Can technology play a role in promoting better financial behavior?

New apps that apply insights from behavioral psychology will be important in figuring out how to motivate the elephant into getting the job done. Apps will also be important if they can help make it easier for riders to figure out where to go.

So those things are moving in the right direction. We just don’t want to be overconfident and excessively optimistic about the degree to which technology can solve these issues.