Want to Make Better Financial Choices? Know Thy Future Self

June 07, 2012

In his last two blog posts, my colleague Michael Smith wrote about two young guys in their early 20’s who are earning about the same amount of money but making very different choices about what to do with it. One is living frugally so he can save for emergencies and a down payment on a home and contribute 15% of his income to his 401(k). He is on track to have a home with no mortgage and $1 million in his 401(k) by age 50.

The second guy is spending a lot more now so he is contributing nothing to his 401(k) and has virtually no savings for an emergency. Instead, he’s hoping to get married and earn more in his job before buying a home and aggressively saving and paying down debt. He also figures that he’ll die young so he doesn’t have to worry as much about retirement.

Both guys are happy with their current lifestyles and comfortable with their plans so Michael concludes that they are both “right” in their lifestyle choices. I’m not so sure. There have been a lot of studies in a growing field called “behavioral finance” around what’s called “inter-temporal discounting,” which is a fancy way of referring to our tendency to irrationally sacrifice tomorrow for today. That tendency may have actually made sense during most of humanity’s history, when our brains evolved to focus on surviving long enough to reproduce. (I’m sure that having enough money for retirement wasn’t on the minds of our cave men ancestors.) The problem is that our society has evolved a lot faster than our brains, which really aren’t equipped to deal well with long term consequences. This has wide-ranging effects, not just in personal finance but also in areas like diet and exercise.

So what can we do about this? Just as our modern, hi-tech society created this problem, it may have the solution as well. Researchers at Stanford University have discovered that people’s behavior can be influenced by avatars, or digital images of themselves, in a virtual world. For example, having an attractive avatar makes people more social and confident in real life. If their avatar exercises, they’re more likely to exercise in real life. It turns out that this works with retirement planning too. Kids with avatars that were older versions of themselves reported wanting to save more because they felt more connected to their future older selves and wanted to make sure they were taken care of. In fact, Allianz is currently working on a tool using this concept that they hope to be able to provide to select financial advisors this summer.

So what can we do until programs like this become more widely available? We can always use one of the most sophisticated tools known to man: our own imaginations. Take some time visualizing your life in retirement and then write it down. Be very specific and have fun with it. What would you look like? (For the less imaginative, there is an Aging Booth app for both iPhone and Android that can age a picture of you. If nothing else, it can be kind of amusing.) Where would you live? How would you spend your time if you didn’t have to work? Some people find it helpful to post images of these places or activities someplace where they can see it and feel inspired. You may even find yourself feeling motivated to save more to make them happen sooner. Who knew that daydreaming could be so productive?

Of course, we all know what can happen to the best laid plans. That’s okay though because hope isn’t the only motivator. Fear can work just as well, if not better. (There’s an old sales expression that if you can get a potential customer to cry, they’ll buy.)  Think about what can go wrong. The second guy in Michael’s blog might want to ask himself what if…

1)      you were to lose your job and took a while to find a new one in this economy?

2)      your future wife wants to have children and stay home with them?

3)      health or job prospects force you to retire earlier than you planned?

4)      Social Security and Medicare benefits end up being considerably reduced by the time you retire?

5)      you end up living longer than you expected?

What will your future look like then? Even more importantly, what can you do now to prepare?

Of course, motivation only goes so far. Here are a few ways to trick ourselves into actually saving more:

1)      Use automatic savings like contributions to your employer’s retirement plan to put money aside before you even have a chance to spend it.

2)      Give yourself a set amount of money in cash to spend each week or month on discretionary expenses like dining out, shopping, and entertainment and don’t allow yourself to get more from the ATM until the following week or month.

3)      It’s easier to stop yourself from spending more than to cut back so try to maintain your current standard of living even when you get a raise or a higher paying job and save most of your bonuses and other windfalls.

The important thing is to find out what works for you. Your future self will thank you for it!