Are your savings gathering more dust than interest?

Funny things, human beings. And never funnier (I mean in the strange sense, not ha ha) than in our dealings with money. If you doubt that, then test which side of your brain is managing your money

We search for the cheapest jar of coffee in the supermarket, tutting at the 30p price difference per jar, then hand over £2.45 for a single cup in Starbucks.

We leave our savings to fester away gathering more dust than interest, while at the same time carrying credit card debt.

Do you know what you;re saving for?
This very specific pot is by terramundi

Behavioural economists call this illogical behaviour mental accounting – or treating money differently depending on its source or label, something I've discussed in earlier blogs about using the left brain a bit more. 

An example is our attitude to money we’ve saved and money that’s dropped into our laps (I know, but bear with me on this one)... 

Would you blow your savings on a big birthday party extravaganza? Probably not, unless that was what you’d be saving for. It would seem too… reckless? Irresponsible? 

But what if you got an unexpected tax rebate and had a big birthday coming up? Woohoo, champagne cocktails all round!

I got to thinking about all this while working on a campaign for first direct, the online bank, to do with offset mortgages. 

Apparently nearly all mortgages in Australia are offset. They originated there and it's what most people go for.

Yet a mere 6% of UK mortgages are offset mortgages. This is probably because this concept feels a bit alien to us. After all, when mental accounting, we Brits have kept our borrowing and our savings very separate. It doesn’t even occur to us that we could use one to offset the other. Mentally they are two disconnected amounts of money.

  

Of course another reason we shun offset mortgages is because we don’t even know what they are.  

Offset mortgages simply allow any savings or current account balances to be offset against the mortgage, with interest only being payable on the difference between the two.

o   e.g. if a borrower has a £100,000 mortgage and £10,000 in savings, they will only pay interest on the difference (i.e. 90,000).

Dead easy really. You use your savings to work for you, but still hang on to them. 

This makes real logical sense for anyone who has both savings and a mortgage, and now more than ever before. Savings interest rates are so abysmally low at the moment, the loss of interest on them would be more than outweighed by the reduction in mortgage interest.

For more info check out the first direct website http://www.firstdirect.com

It's good to talk sheconomics

I loved talking to the Trustees’ Council of Penn Women in the luxurious setting of the RAC Club (not a fluorescent jacket in sight) on Pall Mall last night. Those RAC people are amazing, they can not only fix your car but also serve up some damn good crudites ….

The TCPW are a feisty bunch of bright, high achieving women of all ages and I learned a lot from their comments and questions during our lively session.

We had fun with some of the behaviour economics problems from Sheconomics. To a woman they got the intuitive reasoning problem right (three out of four women usually get it wrong) but they did let their emotions intrude on the ultimatum game. OK, shows they place high value on fairness and social co-operation so it came as no surprise to learn that many work in philanthropic or fund-raising roles.

On the subject of females asking for money, one woman said she can shamelessly extract millions of pounds from others for her cause, but can’t ask for a pay rise for herself. That captures the tendency of the female money psyche to put the needs of others first. It’s what makes us loyal friends and caring individuals, but if we’re not careful it could make us poor too. 

WHICH SIDE OF YOUR BRAIN IS MANAGING YOUR MONEY?

 Here’s a quick question for you:
A notepad and pen together cost £1.10.
The notepad costs £1.00 more than the pen.

How much does the pen cost?

Sixty-four percent of people say 10p. That’s the wrong answer.

The right answer is 5p. The notepad costs £1.00 more than the pen. So the notepad costs £1.05 and the pen 5p, together they cost £1.10.

‘But I can do simple maths’, I hear you cry. Of course you can but sometimes we don’t bother to stop and work things out. And in the case of the notepad and pen question the brain thinks it can take a short-cut. After all, £1.10 and £1 carve up nicely into a difference of 10p, so that’s the answer we give.

The brain is a clever, complex piece of kit. But it also doesn’t like to do more work than necessary. So it automatises lots of its processing, and relegates all kinds of decisions to the unconscious, intuitive part of the mind. That’s good most of the time. If it didn’t you’d have to work out every morning whether your socks go on before or after your shoes and whether that arrangement of features on a human head represents your partner’s face! But automatising some things gets us into trouble.

Aside from being a quirky bit of fun to catch out your mates with, this question also reveals something deeper about people. It can also tell us how good they are with money.

In a recent study I did, in conjunction with first direct, almost two-thirds of the sample got the question wrong. Those people were also more lax with their money. They had more credit card debt and fewer savings.

This study is the first to show a link between a person’s style of thinking and their personal finances. The notepad and pen question is adapted from a test of Cognitive Reflection (Frederick, 2005, Journal of Economic Perspectives). I’ve called people who give the right answer  ‘reflectors’. They use careful, logical thinking; a style linked to left-brain processes.

Those who get it wrong are ‘intuitors’ and more right-brained. They are more impulsive and go along with their gut instinct, even though it’s wrong.

Someone who  is more left-brained and able to stop and reflect can also suppress the need for immediate reward (buy now, pay later with credit) and will give more consideration to the long-term (invest now, benefit later).

Intuitive people can’t suppress the first answer that springs to mind. They’re the kind of people who live for the moment and avoid putting effort into anything that doesn’t bring short-term gain. This was linked to poor money management, such as only making the minimum repayment on a credit card.

Economists have only just begun to analyse how a person’s cognitive skills relate to their financial decisions. Irrational financial decision-making is the subject of a fascinating field of study called behavioural economics. 

This examines why people often act against self-interest. Examples might include:

• -       having both money in savings and credit card debt (where saving get a paltry return and credit card interest rates are mammoth)
• -       Or the strange fact that people are willing to pay more for something when buying with credit card than they would pay if they had to hand over the cash.
• -       Or people who stay loyal to a bank yet moan about the service they receive

Right-brained people might feel dissatisfied with their bank but because they don’t stop and reflect and they’re not great at decisions involving effort, they don’t change it.

In the study 43% of intuitors had been with same bank since leaving school (for some this was thirty years or more)! This is irrational given how much choice there is now and the cash incentives for switching. For example, first direct gives a satisfaction guarantee. They’ll pay people to switch and if they’re not completely satisfied, they can leave the bank and receive a further £100 for their trouble. 
It seems a no-brainer to me.

Here are some other stats from the survey, carried out with over 500 participants:

• ·       66% of reflectors pay off their credit card in full every month (43% of intuitors do)
• ·       Twice as many intuitors than reflectors pay off only the minimum on their credit cards
• ·       Almost one in four reflectors have changed where they bank at least twice (43% of intuitors have never changed bank)
• ·       87% of reflectors have money in savings (70% of intuitors do)

When looking overall at people’s money behaviour the survey also revealed that:

• ·       1 in 3 people over the age of 55 have always been with the same bank.
• ·       Only 1 in 5 young people (18-25) pay off their credit card balance in full every month.
• ·       Men are more likely than women to pay off their credit card in full each month (63% vs 48%)
• ·       1 in 3 young people (18-25) have no savings (i.e. for non-retirement or emergency purposes)
• ·       1 in 4 people aged 25 to 55 have no savings
• ·       Most (92%) over 55s have savings

More info from first direct's newsroom