Deliberately, I resisted the temptation to put the word “inflation” in the title of this first post-holiday column. Is that, during the last weeks, quite comfortably installed in the atmosphere of the holidays, I could note, by wearing only my glasses of reader, that the topic had been largely approached. Yet consumer data shows that consumption is on the rise, which may lead us to believe that we haven’t quite figured it out yet and, more importantly, that many people may still understand too much little about the dangers that threaten their personal finances in the current context.
Financial decisions are not rational
Anyone who has ever tried to change a habit knows that it takes a lot of determination and consistency to succeed. Whether you’re trying to increase your physical activity or reduce your expenses, the challenge is the same. Some consumer habits may be “grandfathered” in your mind! Moreover, behavioral economics teaches us that financial decisions are far from rational, rather they are largely influenced by many cognitive biases and mental shortcuts.
For example, the status quo bias explains that we prefer our routine habits to change. Thus, you are more likely to contribute to a retirement plan if contributing is a default option. And it’s no surprise that, if you’ve always paid for the maintenance of your home, you’re in no rush to question that habit.
Another important bias is that of preference for the present moment. According to a study by Manulife, the majority of plan members given the choice of receiving $100 today or $110 in three days would opt for the immediate $100. People would therefore prefer a smaller reward in the short term to a larger one later. It is then easier to understand why, in the current context, depriving yourself more today to ensure your long-term comfort has not yet resonated with the majority of consumers.
Many people may still have too little understanding of the dangers facing their personal finances in today’s environment.
Finally, the loss aversion bias assumes that the negative sentiment associated with losses is twice as large as the positive sentiment associated with gains. No wonder, then, that investors find it so hard to stay calm when markets are down.
We also better understand the feeling of loss of enjoyment when it comes time to make budgetary choices, especially if they are difficult. However, regardless of your family income, your purchasing power is currently diminished by rising costs. Consequently, you should come to terms with this idea, even temporarily, and reduce certain discretionary expenses.
Mastery or control
The current inflation is the result of many macroeconomic components that you do not control. However, you have the power to control your finances and find the courage to adapt to the situation. Since access to credit is very easy and widespread, the general increase in the cost of living could perniciously compromise your long-term financial goals if you are unable to make courageous and proactive choices.
Although the exercise may seem off-putting, the in-depth review of your budget in order to keep savings a priority remains your most powerful weapon to avoid this destiny.
Many people may still have too little understanding of the dangers facing their personal finances in today’s environment.
Each consumer decision must also be accompanied by reflection. Discretionary expenses (leisure, travel, decoration, restaurants, etc.) are the most difficult to reduce because they are often associated with pleasure. But by prioritizing savings—or perhaps, in some cases, debt reduction—you’re positioning yourself as a proactive manager in the face of economic uncertainty. Large but non-essential expenses could also be postponed.
You will tell me that our economy is based on household consumption and that reacting in this way will plunge it into recession. I’m all for individualism when it comes to personal finance! But anyway, don’t worry: the chances that everyone will apply this difficult rational recipe are slim. But if you do, you will ensure that you are in excellent financial health for years to come.
In personal finance, as in many areas of our lives, we should not underestimate the power of the accumulation of all micro-decisions.
Behavioral economics teaches us that financial decisions are far from rational, rather they are largely influenced by many cognitive biases and mental shortcuts.