Changing Your Financial Habits – COVID-19 Presents a Rare Opportunity
For many of us, the COVID-19 pandemic has created a rare interruption in some of our most basic activities, like commuting to work, allowing us to step back and critically evaluate our everyday habits.
Many of these habits are financial – some good and some bad. If you have ever tried to change a financial habit, such as keeping a credit card balance, you know how hard that can be.
Behavioral economics can help us to reshape our financial habits. It’s a relatively new field that studies the way psychology affects financial decisions. We make myriad money decisions every day, from buying a coffee to purchasing a big-ticket item. Turns out, even seemingly simple decisions are complex, and this field of economics provides insight into the decision-making process.
Chenna Cotla, the behavioral economist in KeyBank’s Financial Wellness Group, explained that right now – in the middle of the pandemic – is an opportunity to think about reevaluating and changing our financial habits because we have distance and perspective that we would not usually have.
Understanding How Habits Drive Financial Decisions
According to Cotla, one of the most important insights to our financial behaviors can be found in Daniel Kahneman’s theory of System 1 and System 2 thinking (or fast and slow thinking). Kahneman, author of Thinking, Fast and Slow, is a Nobel Prize-winning psychologist and behavioral economist.
System 1 consists of fast, automatic forms of thought. It is effortless and unconscious, and uses so-called heuristics – or rules of thumb – to make quick and practical decisions for us.
“When these rules of thumb get paired with a context or an event repeatedly, they become habits,” Cotla said. For example, pre-pandemic, buying coffee on the way to work.
System 2 involves slow and deliberate thought. It is rational and effortful, occurring at the conscious level.
“We use System 2 to make important decisions that are of high personal relevance – and where we are typically held accountable,” Cotla explained. For example, you plan out how much money to put in a college savings fund each month.
Once formed, he said, habits become second nature to how we make decisions, and breaking them is very difficult.
“This is both a strength and a weakness,” Cotla said. “Good habits – such as setting aside a portion of your paycheck in a savings account and making automated transfers to a 401(k) account – can become essential stepping stones for your financial wellness journey.”
On the other hand, he said, some System 1 financial habits can get us into trouble because they may favor immediate pleasure over negative, long-term consequences: “Bad financial habits – for example, impulsive spending – can derail your long-term financial goals and therefore, financial well-being.”
Eliminating harmful financial habits or developing good new ones is hard work, Cotla emphasized. But you can turn to behavioral economics for help.
Nurture the Good Habits, Eliminate the Bad
According to Cotla, it’s important to understand which habits promote your long-term financial well-being and which habits are detrimental. And right now, during the pandemic, is a good occasion to examine these habits – and try to change them.
That doesn’t mean it’s easy. But, he explained, there are steps you can take to help nurture good financial habits – and add to them – and eliminate bad ones.
- First and foremost, get a holistic picture of your finances.
“Bring all of your financial information together using account aggregation tools that most financial institutions offer.”
- Identify and clearly define your short- and long-term goals.
“Your long-term objectives will change over time, but that is OK. One of the ways to prioritize your goals is in the order of emergency savings and readiness; having insurance coverage; retirement readiness; eliminating high-interest debt, such as credit card debt; minimizing other forms of debt, including auto loans and mortgages; and investment goals.”
- Write down your financial habits as they relate to your goals.
“For example, saving habits and spending habits. And map them to your goals and categorize whether the habits are contributing to or deterring from achieving your goals.”
- Identify one or two detrimental financial habits you aim to change.
“You can choose them based on your goal prioritization. Habits are difficult to change, so it is important to start small and scale.”
- Employ your deliberative System 2 thinking.
“Do this to understand the ‘habit loop’ for the habit or habits you would like to change. Habit loops involve three elements: a cue that triggers an action, the actual behavior and a reward. For the coffee example, traveling to work is the cue, buying coffee is the action and enjoying the coffee is the reward. Due to work-from-home arrangements, for a lot of us, some of these habit loops are already broken, providing an opportunity to gain a head start in changing habits.”
- Commit to measurable milestones.
“The reason is to keep yourself accountable and make sure you are making consistent progress.”
Behavioral Economics Can Help. So Can Your Bank
Eliminating harmful financial habits or developing good new ones is hard work, Cotla emphasized. But you can turn to behavioral economics for help. Understanding habit loops for detrimental habits, for instance, can help you plan how to break them.
And don’t forget, he said, to take advantage of the financial wellness resources available through your bank, including account aggregation tools and automated saving and debt paydown tools. You could also make use of online and mobile banking to help you keep careful track of your finances on your own schedule.
Working alone to form better money habits may work for some people, but for others, it’s difficult to change without outside help.
“Leverage your social network to learn by example how you can achieve your financial goals,” Cotla suggested.
You can turn to your banker as well. “A lot of people tend to put aside really analyzing their spending. It’s painful. You want to avoid it,” he said. “But you can delegate this task to a professional.”
Your banker can help review your spending and sort through which financial habits you would like to keep and which to dispense with. You can also arrange to meet on a regular basis to check on your progress. This can be an incentive to stay with your new, better money habits.