Present bias can have a very negative impact on financial planning. We explain what it is and the steps you can take to ensure that it doesn’t derail your financial future.
What is present bias
Present bias is a cognitive bias in human decision-making that leads individuals to choose immediate rewards or benefits over larger, delayed rewards or benefits, even if the latter would be more advantageous in the long run. It is also known as present-focused bias or hyperbolic discounting.
This bias can result in people making choices that prioritise short-term gratification and neglect potential future benefits.
It’s the reason why you might binge on a whole pack of biscuits even though you know it’s bad for you because biscuits taste good and give you a dopamine hit! Or why you never go to the gym, despite paying the monthly fee and knowing it would give you the toned physique you really want, because it takes a lot less effort to lie on the sofa watching Netflix!
Understanding and being aware of present bias can help you make more informed and balanced decisions by consciously considering the potential long-term consequences of your actions rather than focusing on instant satisfaction.
How does present bias impact financial planning
Present bias can have significant implications for financial planning. It often leads individuals to make short-sighted financial decisions that prioritise immediate gratification over long-term financial security.
Present bias may lead you to forego saving into your pension this month because you simply must upgrade your perfectly good smartphone to the latest model. Or to dip into your emergency fund because you really fancy spending this weekend lounging on a tropical beach.
Here are some ways in which present bias can impact financial planning:
- Spending habits: People with present bias may be more prone to impulsive spending on non-essential items or experiences, leading to a lack of savings for important financial goals.
- Inadequate savings: The desire for instant gratification through consumption can cause individuals to neglect saving for emergencies, retirement, or other long-term financial goals.
- High-interest debt: Present bias has been behind the descent into a spiral of debt and financial stress for many people who have used high-interest debt to finance spontaneous consumption of non-essential purchases.
- Underinvesting: Individuals may avoid or delay investing in assets that offer long-term growth potential because they prefer immediate spending or saving in low-yield accounts.
- Procrastination: Financial planning often involves making decisions that may not provide immediate benefits but are essential for long-term financial well-being. Present bias can lead to procrastination in dealing with financial matters.
- Being unprepared for retirement: A common consequence of present bias is not adequately saving for retirement. People tend to prioritise their current lifestyle over future financial security.
- Insurance and risk management: People with present bias may be less inclined to invest in insurance products to protect their wealth, even though they are essential for protecting against unforeseen events.
- Unrealistic expectations: Present bias may lead to unrealistic expectations about achieving financial goals quickly, which can result in disappointment or poor decision-making.
Counteracting present bias in financial planning
Simply being aware of present bias will help you to reflect on your finances and be more mindful of how you spend and save your money.
Here are five concrete steps you can take to establish healthy financial habits to counteract present bias in financial planning:
- Set clear financial goals
Defining specific long-term financial objectives will help you to focus on the bigger picture and resist the temptation of immediate rewards.
- Automate savings
Setting up automatic transfers to savings or retirement accounts will enable you to build savings without relying on willpower to save regularly.
- Create a budget
Developing a budget provides a structured framework for managing expenses and helps you prioritise savings and investments.
- Reflect on long-term consequences
Regularly reminding yourself of the importance of future financial security can help you make more balanced financial decisions.
- Seek professional advice
A financial adviser can provide an objective perspective and personalised guidance to help you develop a comprehensive financial plan. They will act as your cheerleader to keep you on track with your long-term financial goals.
By recognising and addressing present bias in financial planning and working with a professional financial adviser, you can plan more effectively for a secure financial future.
Why not set up a meeting with one of our advisers across Asia and get expert advice and support in your financial planning?
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