Have you ever made an impulsive purchase? Do you struggle to stick to a diet or exercise routine? What’s the longest you have gone in keeping your New Year’s resolutions? The field of behavioural insights tells us that we have an innate desire to live for today at the expense of tomorrow. Present bias is our preference for short-term rewards over long-term rewards, even when the long-term reward is more valuable. Find out more about present bias and how it could impact your financial decision-making.
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What is present bias?
Present bias is a preference for immediate rewards over future rewards, even in cases when the future reward is of greater value. It also includes a preference to avoid incurring costs or exerting effort in the near-term. Other terms used to describe present bias include instant gratification, hyperbolic discounting, and short-termism. With present bias, people make decisions so today will be more pleasurable or less painful, even when they know it is not in the best interest of their future self.
What does present bias look like?
Present bias shows up in many aspects of peoples’ lives. Here are a few examples:
- Exercise – While the benefits of exercise are clear, and the costs of not exercising equally clear, our preference for immediate pleasure pushes us to watch TV instead of going to the gym. People often choose the short-term benefit of TV over the long-term benefit of better health.
- New Year’s resolutions – Many New Year’s resolutions involve building some sort of habit, whether it be reading books or learning to play an instrument. But when push comes to shove, present bias kicks in and people choose to avoid the effort required today to build the habit.
- Procrastination – A classic example of present bias, procrastination involves putting off things we don’t want to do so that we can do something more enjoyable. Procrastination can show up in a lack of self-control at school, work, or even odd jobs around the house.
The common theme in these examples is that people choose immediate rewards over future rewards. Even though people are aware of the long-run costs of this behaviour, they still choose to do it. This demonstrates the power and influence of present bias on our decision-making.
Our individual behaviours are prone to bias. That can make financial decisions challenging. Try our behavioural bias checker to understand how biases might be affecting your financial decision making.
How could present bias affect your financial decisions?
Present bias can impact your financial decisions in several areas:
- Spending – Businesses take advantage of present bias every day. Marketing campaigns encourage people to “live for today” by spending on the latest product, service, or experience. While spending can feel good, it’s important to ensure that you are considering your future financial situation as well.
- Frauds and scams – Fraudsters exploit present bias to take advantage of people. Many financial frauds and scams promise high returns and easy money. People are attracted to the opportunity to make money quickly with minimal effort, rather than invest in a diversified portfolio. Pursuing the promise of immediate returns can result in people losing a lot of money.
- Retirement savings – The decision to save money runs completely counter to present bias. People earn money and can either spend it on a reward today or save it for a reward in the future. One of the main reasons why people struggle to save enough for retirement is because present bias pushes them to live for today by spending instead of saving.
It’s important to recognize the areas in which present bias can affect your financial decisions. The implications of this bias can be very costly in the long run. Counteracting its effect on your behaviour begins with recognizing its presence in your life.
How can you protect yourself from present bias?
There are several useful strategies you can use to minimize the effects of present bias on your financial decisions.
- Picture your future self – People have a difficult time appreciating the long-term impact of their financial decisions. One way to combat present bias is to picture your future self and ask yourself what you need to do to support that person. You might even consider writing a letter to your future self, promising to take certain actions to secure their financial state.
- Delay major purchases – Instant gratification is a powerful motivator. When you are considering a major purchase, you can often be in an emotional and impulsive state. To counteract this, give yourself a period of time (e.g., 14 days) and re-evaluate the purchase. You will be in a less emotional state and might find that it isn’t worth the money after all.
- Start small and automate – When building habits around decreasing spending and increasing savings, it’s a good idea to start small. Saving 5% of your income is more manageable than 20%, and this will help you build the habit over time. When possible, it’s also smart to automate your savings – so you don’t even have to think about it.
These tactics can be very effective in helping you overcome the strong effect of present bias on your behaviour. Over time, they can work wonders in building your wealth and financial stability.
Learn more about other behavioural biases which might be impacting your financial decisions in ways you may not realize.
Summary
Present bias is one of the most challenging behavioural biases to manage. Here’s how it works:
- Present bias is the tendency for people to prefer immediate rewards over future rewards, even when the future reward is of greater value.
- Other terms for present bias include instant gratification, hyperbolic discounting, and short-termism.
- This bias can impact a range of financial decisions and cause you to spend more, save less, and potentially fall prey to financial frauds and scams.
- You can manage the effect of present bias on your financial decisions. You can consider your future self, delay major purchases, and build savings habits by starting small and automating your savings behaviour.
