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So, let’s use this example to show why using the ‘give up your coffee’ is so compelling. Assume my £4 coffee was not a fluke and that I pay that every day, 5 days a week. Even if I’m on holiday, just to make things easy. Also assume that I save up all my coffee money and invest it at the end of the month. I do this every month for 20 years and I earn 5% on this investment each year. I also get tax relief of 20% on the £80. Like magic, my £4 a day becomes £33,545.60 after 20 years. Compelling stuff. Assuming you’ve kept on reading after all the % signs, pre and post tax explanations and many many assumptions.

It’s clear that compound interest and tax relief are the real magic of pension savings. So, why is using this example not a good idea? The numbers speak for themselves, surely! Turning £4 into £33,545.60!

Behavioral economics blends insights from psychology and economics, and provides a powerful lens through which we can analyze and improve decision-making when it comes to money. Behavioural economics strongly suggest that this example will fall flat on it’s face. Why?

Loss Aversion

We feel the pain of a loss more than we feel the pleasure of an equivalent gain. Twice as much in fact. It is a psychological bias which has a big impact in the context of pensions and financial wellbeing. It can result in a reluctance to take risks, or, in this example, prevent us from seeing the benefit of giving up that cup of coffee. Instead of focusing on giving up the coffee, highlight what will be lost in savings when an £80 investment a month isn’t made.

Present Bias

We prioritize immediate rewards over future gains. If you think about it from an evolutionary perspective, it makes sense. We need to survive today and the future is very uncertain. Especially the very far future. Who knows if we’ll even be here? And we also think of our future selves as strangers! When saving is a long term game, like saving for retirement, present bias will influence saver behaviour. Framing pension contributions as a present gain and focusing on what will be lost (or missed out on) if we neglect our future selves will encourage savers to overcome this bias and make more forward-thinking decisions, in the present.

Affect Heuristics

This mental shorcut involves making decisions and judgments based on emotions and feelings rather than a thorough analysis of the available information. It is a cognitive bias where individuals rely heavily on their emotional response to a situation, person, or event to determine their attitude or judgment, often bypassing a more rational and objective evaluation.

So what?

So when we ask savers to give up their cup of coffee, from a rational perspective it may look like a no brainer. But from a human perspective, you’re asking them to give up something that brings joy, someting that is in their control; a specific present gain. Where the gain is unknown so far into the future that they cannnot feel a connection with that person. On top of that you’ve tried to convince them by using lots of calculations, something our System 1 brains are going to try and avoid, unless you manage to get their System 2 brain interested and engaged.