Aug 22 2016
Enhancing Savings Behaviors of Low- to Middle- Income Families
If we are to help low- to middle-income households make better financial decisions, we first need to understand why they sometimes don’t. To do this, we need to explore the psychology of decision making.
Pete Foley Innovation
Report Number 406
Managing personal finances is challenging and complex. We all make a great many financial decisions every day, often without thinking deeply about them. But virtually every one of them represents a trade-off of some kind. For example, if you spend too much on groceries or make an impulse decision to treat your family to a meal out at a restaurant, it can limit your ability to pay for other immediate needs, such as utilities, rent, or transportation. The impact of these trade-offs can add up to have a major impact on our financial well- being, and can be particularly problematic for vulnerable low- and middle- income families. People who live paycheck to paycheck have little room for error, as they often lack savings or rainy- day funds that act as financial buffers. Without buffers, these individuals often have no choice other than to borrow their way out of difficulty, often creating cycles of debt that are difficult to escape from.
Of course, if we were purely rational beings, with infinite time to weigh and evaluate every decision we make, we would always make financially optimal decisions when facing a trade-off. However, in reality, we have limited time and limited mental resources available to navigate the multitude of choices we face every day. To manage this, we frequently rely on emotions and mental shortcuts, as well as, or even instead of, rational evaluation to make decisions. These help us to manage choices in a timely fashion but can also result in our making mistakes. The potential to make mistakes is further compounded by our surrounding environment, which is often filled with advertisements and offers that are tuned to our biases and influences.
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