Are you being tricked into debt by your own mind?

Have you heard of “present bias”? It’s not wanting a jumper for your birthday rather than a bottle of wine, it’s a behavioural economics term for a self-delusion that everyone suffers from to some extent. It affects many areas of life and one of the most important is making poor decisions about money – present bias makes it easy to get into debt and much harder to climb out.

All too often we make an easy / fun / downright bad decision about what to do now, in the expectation that in a few days or weeks or months we will make a better decision, so everything will be fine. But when the future arrives, do we then do the best for ourselves that we expected we would choose? No, we don’t.

If I start with some non-monetary examples, perhaps I can convince you of just how common present bias is.

Grocery shopping, Netflix and procrastination

You turn up at the supermarket needing food for the rest of the week. Into the trolley go broccoli (super food!), a pile of salad, buy-one-get-one free crisps (money-saving!), potatoes, a chicken (can roast it and have left overs) and some pizzas where there is a special meal-deal. No prizes for guessing what you choose to eat this evening – it’s probably the pizzas, with some crisps whilst they are cooking. You’ll cook the chicken with roast potatoes and broccoli tomorrow … except tomorrow you’ve had a tough day at work, get home tired and opt for a take-away. The day after, you go out after work. And then the chicken has gone off and the lettuce has gone soggy :(

If you have Netflix or a similar subscription, you probably have a long queue with some really great films in it that you keep meaning to watch, but this evening once again you don’t quite fancy any of them and decide between a comedy and a couple of episodes of “Orange is the new black.” It’s not just you, everyone does this. I had an interesting few books planned to read on a recent holiday, I was looking forward to them, but at the airport I once again bought a thriller and guess which book I read on the plane? It wasn’t very good either.

Got an important report to write for work? Need to revise for an exam? Tax return to complete? If it doesn’t have to be finished for a few weeks, you are probably going to put it off. At the weekend, you will have so much more time to really get stuck into it…

The common factor with all of these is that we expect to “be good” next week, so we can afford to do what we want this evening, choosing to postpone going for a run or making a start on clearing out the attic in favour of something more immediately appealing. But next week, the easy choice once again is more attractive, and so we put off being good for another week.

How present bias got you into debt

Most adults know that they aren’t very good at taking long-term money planning decisions. We spend too much on holidays compared to the amount we save for our pensions, or don’t want to cut back on entertainment to pay for life assurance. But the insidious nature of present bias runs much deeper than that – because we are consistently too optimistic about our future behavior our minds justify taking the ‘easy’ decision now and postponing less pleasant ones until later.

Small decisions can add up to a lot of money over time: a coffee on the way to work, getting your lunch from the sandwich shop every day, upgrading your mobile phone when your contract ends, renewing your car insurance without shopping around etc.

Present bias also shows up in borrowing now because you have an unusual expense, justifying it to yourself because you know it’s not going to happen next month. So this year’s Christmas presents go on your credit card, as does a new washing machine. When the credit card is at its limit, it may seem simpler to take out a payday loan than to tell your mates you can’t go on the stag night. But if you can’t pay for it this month, what is the chance you can really pay the loan off next month?

And how it affects climbing out of debt

If you aren’t careful, present bias can sabotage your plans to get out of debt:

• a consolidation loan is usually taken out with the admirable intention of reducing the interest on expensive credit card debt and making it simple to paying off the debts, but all too often the cleared credit cards are not closed down and soon start to be used for new spending;
• planning to snowball your debt, you never seem to have as much money left at the end of the month as you should;
• can’t seem to stick to your budget? You may be being derailed by small everyday spending decisions that individually don’t seem that important.

Now you know what it is, you may find yourself recognising present bias all over the place.

That doesn’t mean it’s going to be trivial to banish, but knowing the tricks your mind is playing is a useful first step because it suggests strategies you can employ to beat it. Basically these come down to making decisions further in advance and  trying to ensure that you have options available which are both cheap and easy for those times when you know you tend to make bad immediate decisions. These could include:

• meal plan for the week before you go to the supermarket and only buy what is on the list so you don’t throw food away;
• always have a couple of easy meals in the store cupboard or freezer so you don’t have to choose a takeaway;
• look at a simpler way to snowball that is more automated;
• set aside a regular hour a week for updating your budget and boring financial tasks you tend to postpone such as your work expenses claim or seeing if you should switch electricity and gas suppliers.

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