Inflation continued to rise 8.5% in July, so here’s how to stay on track financially with tips from behavioral researchers.
Finding ways to control spending and funnel more money into savings is always a challenge. And as inflation continues to rise (up 8.5% in July from a year earlier) it’s becoming increasingly difficult to save money and stick to a budget.
Rising prices are driving many consumers into debt. According to a recent report from the Federal Reserve Bank of New York, U.S. household debt rose to $16.5 billion in the second quarter of 2022, a 2% increase from the previous quarter.
Fortunately, there are ways to increase savings that are relatively simple. The key is to use strategies based on behavioral research that tap into your mental characteristics and emotional responses to avoid making poor financial decisions.
“By understanding your behavior, it can be easier to stick to a long-term financial plan,” says Meir Statman, professor of finance at Santa Clara University in California and author of “Finances for Normal People.”
To help you stay on track toward your savings goals, consider these four guidelines.
Adopt a long-term perspective.
The recent rise in inflation is frightening, but don’t let fear lead you to make risky investment decisions or discourage you from saving.
“People often make the mental mistake of proxies, which is thinking that the recent past will extend into the future,” Statman says.
Instead, keep a longer-term perspective. Although inflation has risen recently, rising prices have not been the historical norm. Average annualized inflation rates over the 3-, 5- and 10-year periods ending in 2021 were 3.53%, 2.92% and 2.14%, respectively, according to Morningstar Direct, an investment data provider.
Inflation is expected to slow over time as supply chain issues are resolved, as has been the case with gasoline prices. And in the short term, if prices continue to rise, the Fed will raise interest rates further, although this carries the risk of recession and high unemployment, Statman says.
Just remember to stay focused on your long-term financial plan, which should be designed to weather this kind of economic upheaval. And keep a close eye on your budget and spending to make sure you continue to save.
What to do: As a hedge against rising prices, maintain your participation in I-Bonds, which automatically adjust for inflation and are backed by the U.S. government. And for additional assistance, consider working with a certified financial planner, who can offer professional guidance.
Set small savings goals.
“When you want to save, it’s often easier to break goals into smaller steps,” says Hal Hershfield, professor of marketing and behavioral decision making at UCLA’s Anderson School of Management in Los Angeles.
In a recent study, Hershfield and fellow researchers Shlomo Benartzi and Stephen Shu analyzed the impact of suggesting to new users of a financial app that they save small daily amounts of $5 versus a monthly amount of $150. In the study, presenting the savings option as a smaller sum was shown to cause the number of consumers signing up for the program to quadruple.
“There is a disconnect between our present self and our future self, which makes it difficult to sacrifice in the present for our future needs,” says Hershfield. “But framing savings in small amounts makes it easier.”
What to do: Whether you use a financial app or a 401(k) plan to save, automate your savings, even if you start with a few dollars a day. Chances are you won’t feel that money missing. And you can gradually increase the amount: many 401(k) plans will do this for you automatically, so the money actually saves.
Save your smartphone
With the rise of smartphones, apps and other digital innovations, it’s easier and more convenient to manage your finances and everything else, which is why people are constantly checking them. But these devices have a downside: having a smartphone is distracting. Even having one nearby can affect your mental abilities.
That’s the result of a 2017 Analysis published in the Journal of the Association of Consumer Research that measured the impact of smartphones on cognitive tasks. The researchers conducted two tests where they assessed memory capacity and problem-solving ability. The subjects’ smartphones were placed at different distances: on desks, in pockets or bags, or in another room. Based on the results, it was concluded that, in general, the closer the smartphone was to the subject, the worse the task performance.
“Having your smartphone nearby demands attention, even when it’s out of sight, and resisting that demand reduces people’s cognitive capacity,” says the study’s lead author, Adrian Ward, a psychologist and assistant professor of marketing at the University of Texas at Austin. “That can make people more susceptible to making impulsive, rather than analytical, decisions.”
What to do: When shopping, managing your finances or doing anything that involves concentration, try to put your device away. “When I’m doing difficult work or preparing to teach, I put my phone in a corner, out of my sight,” Ward says.
Focus on your financial cushion
The biggest obstacle to saving is that it requires sacrifice: you must stop spending now to reap rewards in the future. But once you start saving money, you have immediate rewards: you have the benefit of having a cushion of money that can help you in financial emergencies.
“Often, people don’t notice that having money in the bank today has an emotional benefit,” Statman says. “You don’t have to go through the embarrassment of having to ask your brother for money or go to a loan shark if your car breaks down.”
If you’re saving in a tax-sheltered retirement account, such as a traditional IRA or a 401(k) plan with no tax liens, you can also enjoy the satisfaction of knowing you’re getting a tax break from the government. The 401(k) can also have an employer matching contribution, which will help you reach your goals faster.
What to do: Make your initial savings plan a habit. “Once you start saving, it builds on itself,” Statman says. As you see your balance grow over time, sticking to the plan will become easier.