A Guide For Those Who Want to Save Money
The Cappuccino Savings Pot
Q: What would happen if you took the money you might spend on a coffee and put it into a savings account or a pension - how much would you have?
A: It's likely to be bigger than you think, not just because you will be earning interest on the savings - but because of the magical effect of compound interest.
“Compound interest is the 8th wonder of the world. He who understands it earns it. He who doesn’t pays it.” Albert Einstein (usually atributed to him anyway)
Benjamin Franklin described the effect as "Money makes money. And the money that money makes, makes money."
That's why debts can grow very quickly. Taking out a loan with simple or compound interest rates can significantly affect your loan repayment values.
A loan of £2,000
1: If you took out a simple interest loan of £2,000 at a yearly rate of 5% and a three-year term, you would pay £2,300 over the full term.
2: If you took out the same £2,000 loan for 3 years at 5%, compounded yearly, you would pay £2,315.25 over the loan term.
3: If the loan were compounded monthly, however, you would pay £8,192.00 on the same £2,000 loan – nearly triple the value of the original principal.
So what does this mean for me saving my coffee money?...
A Starbucks cappuccino costs around £4. So one every day is about £80 a month. A 35 year old who drank one less cup of coffee a day and put the money in a savings account saving 4% instead would have around £59,000 when they retired.
A higher rate taxpayer who put their coffee money into a pension which was making 4% would be making around £98,000 when they retire - because they benefit from the tax-refund from pension investments, which grows at a compiund rate,.
Mind Over Money: The Psychology Behind Saving
1: Pay in Cash for More Pain & More Gain
The system makes it easy to buy stuff without paying attention. Contactless payments mean you dont even have to do aything, uoui just mindlessly wave your phone near the till. Adding friction to the transaction - taking time to consider, make a big difference to helping you manage your money.
If you draw out the momney you want to spend each week in cash and only spend that - you are much more likely to keep to a budget. There are a number of studies which show that the pain of paying in cash, actually reduces the amount you spend - by making you much more aware of what you are doing and its implications.
But paying in cash may do more than keep you on budget, it might make you cherish the things you have bought more than if you paid electronically.
Paying In Cash Makes Things Feel More Valuable
Professor Shah conducted a study at Duke University in. the USA. She decided to sell discounted mugs with the Duke University logo on them to school staff and faculty in their offices. She asked one group to pay $2 for the mugs with cash. The other group had to pay with a card.
Then Professor Shah returned to each purchaser two hours later and said she needed to buy the mug back. To soften the blow, she asked the buyers to name their price. The people who had paid for the mug with a card asked for an average of $3.83 back, while those who had paid with cash asked, on average, for $6.71.
2: The Rounding Up Ploy
If you are using one of the app banks - they often have a rounding up feature that pushes the price of the thing you are buying up to the nearest pound and then saves the extra you have spent into an automatic savings pot.
3: Save by Thinking About Buying Something
Usually we think about saving as a process which is negative - it's about not doing something rather than doing something. We are saving by NOT buying that coffee, shirt, cinema ticket or glass of wine. That's a bit of a downer - who has joy in not doing something.
But if you think of something you want to do - something you want to buy - each time you save something it is a step towards that goal. Instead of focusing on how much you’re “missing out” by not buying a new gadget, think about how much you’ll lose from your savings if you spend the money. Shift your mindset to treat unnecessary spending as a loss to your financial future.
This can work well because we are much suspetible to loss aversion. we don;t want to lose something much more than we are interested in gaining something. So if we think that spending today will lose us something in the future, we are more likely to be able to spend.
Saving Pots
It feels rather old fashioned to have a piggy bank or multiple jam jars - bnut I find it really works. The app banks have virtual saving pots - so yuo can save for a holiday, clothes, Christmas etc. You can even make these savings pots earn you interest.
You can unlock the pots if you need to - but it seperates the money from easy access and not only helps save but also helps you budget for the future payment. So if you are saving for a holiday - you know how much you have when you get there and know what you should be spending, rather than spending now and just tryingmto pay back the debt on the credit card when you get home.
Anchor Your Expectations to Lower Prices
Rolls Royce has supposedly stopped exhibiting at car shows because a Rolls looks very expensive compared to most cars. Instead they started shoowing the latest models at provate jet and yacht shows - where by comparison a Rolls looks cheap.
In trying this marketing strategy, they are using a sales trick called anchoring. We tend not to have a great intrinsic idea of what a product should sell for. Instead we make a judgement about whether it is cheap or expensive by comparing it to other similar products or those nearby.
So if we see a jacket for £90 - that might seem expensive. But if every other jacket in the shop is £150 or more, it suddenly looks like an amazing bargain, and we are much more likely to pay the £90.
To re-exert control over your spending it might be a good idea not to persuaded by the anchoring effect shops are using but working out what you want to spend before you go shopping. If you really only can afford £50 - then when you see the £90 jacket you will be much more in control of your budget and know whether you really want to bust the budget to buy the jacket or keep to the budget and control your spending.
Don't Miss Out
Listen to Money Matters on Times Radio with me, Fi Glover and Jane Garvey at 3:45pm
For more commentary follow me on Twitter/X and BlueSkySocial @adamshawbiz
This is a journalist commentary and is not advice
If you want to contact me - send an email via here