Impact of Present Bias on Individual Financial Management
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In an effort to improve his financial health and secure a prosperous future, Samuel, a 35-year-old individual, is tackling the challenge posed by the present bias – the tendency to prioritize immediate gratification over long-term benefits. This common behavioural pattern can lead to unforeseen expenses that hinder achieving financial goals.
To manage the present bias and protect his savings, Samuel can employ several strategies:
- Create a detailed financial plan with clear, vivid goals. Translating a portion of his income into what it enables him in retirement can help his brain value future rewards more appropriately.
- Commit to disciplined spending and saving habits. By consciously choosing to spend less than he earns and automating savings, Samuel can reduce the risk of succumbing to short-term temptations.
- Use regular investment rebalancing and goal-based allocations. Setting an ideal investment allocation aligned with his long-term goals and routinely rebalancing to maintain it will limit emotional decision-making and help him buy low and sell high without trying to time the market.
- Engage a trusted financial advisor or planner. An advisor can act as an objective mirror to spot when his biases may be influencing decisions negatively, help keep his focus on his goals, reduce emotional reactions, and provide reassurance during uncertain periods.
- Reframe his financial mindset from short-term urges to long-term growth. Instead of chasing immediate high returns, Samuel should focus on consistent compound growth and maximizing the productive use of every dollar (a concept called Return on Volume). Using financial vehicles with guaranteed growth and tax advantages, like whole life insurance policies, can help build steady wealth over time.
Financial education is crucial in managing finances effectively, and opening a savings account and setting up automatic transfers can help Samuel save money regularly. Making a shopping list can help keep his costs down, while regularly checking home appliances, vehicles, and other machines can help prevent unforeseen repair costs.
By implementing these strategies, Samuel's financial understanding and management skills will improve, allowing him to meet current obligations and achieve future goals. His risk of over-indebtedness will reduce, and his savings will start to grow, creating a safety net for unforeseen costs.
References:
[1] Thaler, R. H. (2015). Misbehaving: The Making of Behavioral Economics. W. W. Norton & Company.
[2] Ariely, D. (2010). Predictably Irrational: The Hidden Forces That Shape Our Decisions. HarperCollins Publishers.
[3] Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263-292.
[4] Thaler, R. H., & Benartzi, S. (2004). Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings. The Journal of Political Economy, 112(6), 1113-1156.
- Samuel's pursuit of financial health includes the exploration of digital banking platforms for improved financial inclusion, as they can facilitate easier access to personal-finance management tools and savings accounts.
- To complement his financial plan and savings strategy, Samuel also prioritizes financial education, seeking resources to enhance his understanding of investment, personal-finance, and saving best practices.
- As part of his commitment to disciplined saving and long-term financial growth, Samuel integrates automatic transfers into his budget, ensuring a portion of his income is consistently directed towards his savings and personal-finance goals.
