Where Does Your Money Go?

Money Balance

Managing your money is a balancing act between today’s and tomorrow’s wants and needs; focussing too much on one will have a detrimental effect on the other.

Most people have a focus on the here and now, spending money on today’s wants and needs. Psychologists refer to this as present bias, or, to use the more technical term, hyperbolic discounting. This present bias is the tendency to put greater importance on immediate rewards rather than waiting to get a greater reward later.

Experiments have shown that people tend to prefer to receive a reward of say, £100 now rather than £120 in a year’s time. This cognitive bias is likely to be an evolutionary trait from when our ancestors couldn’t afford to wait to see if a bigger or better meal came along in the future.

What is interesting though is that if both rewards are delayed and a £100 is to be given in twelve months or £120 in thirteen months, most people would choose to wait the extra month to get a bigger reward. Both rewards are in the future so it is easier to way up one against the other.

The problem with the bias is that focussing too much or purely on the present and ignoring the future creates a problem when the future eventually becomes the present. I.e. that point in time when we decide we no longer want to work but find we can’t afford to stop. The result is the need to keep working or accepting a retirement lifestyle that is less than we are used too.

We can kid ourselves that our decision to focus on the present is the right one: “I might get run over by a bus tomorrow” but the probability is we will live a normal life expectancy. Which, for most people, means living into their eighties and for those being born today, into their nineties and beyond.

The cost of living today is high, particularly with children to clothe, feed and perhaps educate too which, when coupled with mortgage costs and utility bills can leave little for retirement planning. It, therefore, becomes a need to prioritise what is most important to you and using your money accordingly

In my experience (and understandably), most people with children will prioritise their financial security above all else but that doesn’t mean that some money can’t be allocated to the future. As and when children fly the nest planning for life after work can then take precedent and saving into pensions and ISAs etc. can be increased.

Ideally, because the cost of plugging gaps in any financial shortfalls becomes greater over time (there is less time for compound interest to work its magic), both the present and the future can be managed simultaneously.

If your career or business is on a trajectory that enjoys jumps in income above inflation one strategy to make sure your future self is being looked after as much as your present self is to save at least half of any pay rises. That way you avoid the lifestyle creep of living to your means and it ensures that more is being diverted to your long-term financial independence and security.

I said at the start of this article that there is a balancing act between managing today’s and tomorrow’s wants and needs and, whilst there is an absolute need to look after one’s future self, going too far the other way may also lead to regret. Life should also be about enjoying and being grateful for the present; I don’t believe lasting fulfilment and happiness comes from the acquisition of more and more stuff. I do believe in the importance of enjoyable experiences.

Research has shown that it is positive experiences that are a source of happiness, not just in the moment but from the memories long after the event has finished. I’m grateful to have enjoyed many wonderful experiences that will stay with me as long as my memory allows, some of the experiences were of minimal cost but others, particularly travel, cost a quite a bit. I could have saved the money for the future but I believe I would be poorer in the experiential sense as a result.

So, there really is a balance that has to be struck between living in the now and planning for the future. However, without knowing what it is that you value that balance is likely to be skewed one way or the other.

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