There are various profit-driven business models in the market competing for our money. Free basic products that promise value if upgraded to a premium account, recurring low subscription payments, status signalling goods that we can buy in instalments, cheap fast fashion with a short life span, that daily Starbucks coffee amongst others. Such commitments are small, insignificant and could be the reason we are unable to accumulate a lumpsum or meet our savings goal. As James Clear puts it, we tend to dismiss small missteps not knowing that they compound into toxic results. Commitment devices are powerful tools for improving financial behaviour as they allow us to limit our future spending by redirecting our income to specific financial goals. How many of our financial pre-commitments are driven by our financial goals? Are these commitments increasing our wealth? Unfortunately, most of our financial pre-commitments are market driven with the goal of encouraging consumerism.
Just like with time management, if we do not set our financial agenda, best believe someone else will schedule their interests. Saving is difficult even for the most sophisticated people, acknowledging this and utilising commitment devices will help us. We should set up our ‘big rocks’ before committing to non-essential financial contracts. If we do not, we will dismiss the small funds in our accounts as insignificant and shy away from investing – hoping to get in the game once we have a substantial account balance. If you experience such struggles, a simple bank standing order to a locked savings account might help you regulate your consumption. You could also consider an asset loan that pre-commits you to secure your financial future and that has an economic value. Otherwise, there will always be a justifiable reason to spend money that is easily accessible. Especially now with services such as Buy Now Pay Later that are enticing us to accumulate consumer credit with no value addition or compounding gains to our wealth portfolio.
We can think of savings as a choice to postpone consumption to a future date. That could be for emergencies, retirement or to afford an asset at a later date. Most of us struggle to meet our savings goals due to lack of self-control, inertia and procrastination. We tend to be overconfident in our ability to meet our goals tomorrow ignoring the fact that we will face the same obstacles we faced yesterday. Uncertainty and lack of financial expertise also contribute to this struggle leading to over-analysis and decision paralysis.
Long before I sat in a behavioural science class, I watched bankers optimise pre-commitment devices. After probationary period, most banks in Kenya offer loans at preferential rates to their staff. The loans would either be a study loan, a mortgage, construction loan, land loan and obviously a car loan! On average, most of the staff loans were “good debt” in the sense that they increased net worth. Such illiquid assets protected bankers from consumption splurges by reducing their disposable income. In addition, regardless of competing financial demands during the month, the key financial priorities were sorted. Promotions and salary increments gave them a headroom to get another loan or a top-up to maximise their benefits. As a result, most of them were ‘broke’, and sometimes made the best customers for bank credit cards. Despite this, they were able to accumulate assets over time and had a better net worth compared to their colleagues in other industries who had higher salaries and flexible saving or investing strategies. This is because consumption tracks income especially if we do not prioritise and pre-commit to our key financial goals.
A simple pre-commitment device can be the differentiator for your net worth in a few years or in retirement. These can be pension schemes, business equity, government securities, mutual funds or the traditional real-estate. Before you subscribe or agree to that contract, make sure you evaluate it’s utility.