A fully flexible way to invest
5 minute read
Scientific theory suggests subtle pushes can help us take important steps to saving and investing for the long term.
Who's it for? All investors
The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.
It’s easy to put off doing important things – such as starting a savings strategy sooner rather than later. But scientific theory suggests that with a bit of external nudging it is possible to ignite a lifelong habit that will reward you in the future.
The concept of ‘nudge theory’ attracted widespread attention in 2008 when Nobel prize winning American behavioural scientist Richard Thaler and Cass Sunstein published the book Nudge: Improving Decisions About Health, Wealth and Happiness.
Nudge theory centres on how subtle measures can affect the choices we make without limiting our options. Governments and other organisations can use these nudges to prod us and help steer us towards making better decisions.
The idea is that by making the choices easier to act upon, individuals will behave the way the nudging organisation wants.
You will have experienced its gentle force on many occasions – often without knowing it.
One high profile example we are all now familiar with is the message that we should all be washing our hands for 20 seconds (while singing Happy Birthday to ourselves twice) to help combat the spread of coronavirus.
This initiative is one of several conceived by The Behavioural Insights Team – also called the Nudge Unit. Originally set up in 2010 by David Cameron when he was prime minister, it is now a charitable organisation that works with the government and other organisations.
Rob Smith, head of Behavioural Finance at Barclays Smart Investor says nudging is about trying to guide people’s behaviour using knowledge of what influences how we make decisions. Hopefully this is used positively to encourage people to make better decisions.
When it comes to finances the message of nudge is that by saving sensibly for the future we will hopefully become self-sufficient and less of a financial burden on society – and, importantly able to live the retirement we hope for. When faced with complex choices, such as when investing, nudges can be useful in preventing us from making decisions based simply on hunches or previous behaviour.
He said: “Little nudges can help take the mental load away as well as the emotional difficulty of making decisions.”
Although nudges are normally used by governments and institutions to influence our behaviour, we can use the idea behind the theory to help us make the choices, which are better for us, easier.
Most people know it makes sense to save for a rainy day. But how do you motivate yourself to take that first step and how much should you save?
Messages such as what would you do if the boiler broke down tomorrow can be enough get you to spring into action. This chimes with a much-repeated recommendation by money experts is to keep at least three to six months of income in an easy access account in case of emergency. In the wake the coronavirus crisis many would be grateful to have even more to fall back on in their emergency pot.
The first step is often the toughest but once taken can trigger an enduring savings habit.
Setting up a direct debit or standing order from your bank account into a savings account is quite simple to do – and from then on the regular saving is done for you. It can help to arrange for the payment to go out just after payday so it feels just like another household bill – but with the reward of seeing the money mount up.
Technology is being used by providers to help steer you into developing good savings routines. Certain apps can analyse your spending patterns and work out what you can afford to put aside, sweeping spare money automatically into a selected savings account. Some of these apps offer additional prompts to encourage you to add to your pot if or when you have money to spare.
Nudging people into investing can be a greater challenge than persuading them to set aside money in a savings account.
Smith points to more complex barriers to leap to open an investment account, from the process of setting it up to choosing from an array of investment options.
Smith said: “Investment is seen as a risky activity.” So the nudges used to encourage people are mostly around education to get people to the point of making decisions.
“The focus tends to be more on what you lose by saving in cash, including the fact interest rates are very low at the moment and probably will be for some time and that inflation will bring down the buying power of that money.” Though it is always clear that there is a risk of loss when investing too.
Once you take the first step into investing, having decided you don’t need this money in the short term – and that you could lose it if markets turn against you, the nudges tend then switch to other matters. This includes ensuring you are diversified and whether you might want to invest regularly rather than make a lump sum investment – so you don’t have to think about timing your investment purchase.
The ISA allowance is a type of nudge to saving and investing. With a new tax year underway and a new allowance of £20,000 available to all adults it can sometimes feel the social norm to invest in one. A generous amount can be sheltered from HM Revenue & Customs, which can add to the appeal of investing. Though remember tax rules can change and their effects on you will depend on your individual circumstances.
Since millions of people do have ISAs you might ask yourself, ‘well maybe I should do it too?’.
Investors, whether investing inside or outside an ISA, who have decided to get started can nudge themselves in just the same way as savers – setting up a direct debit or standing order or signing up for an app that sweeps excess money into an investment fund rather than a savings account.
Account holders will often receive prods at key moments; such as why it might be a good idea to take advantage of your ISA allowance earlier in the tax year rather than later to beat the rush before the year-end deadline. Or when the end of a tax year is looming, reminding them they have some allowance left, which if left unused will be lost forever.
Government is also playing its part. It has been applying the ultimate nudge for pension savers for the last eight years by enrolling millions of employees into workplace schemes for the first time and automatically deducting contributions via payroll into a retirement plan. Importantly, auto-enrolment is not compulsory, as you’re free to opt out of your employer’s scheme. But by signing people up first, they can hopefully see the benefit of investing for their long-term future and acquire a vital savings habit without requiring much willpower.
This is a great way to ensure people start saving towards their retirement but on its own, it may not be enough to provide the level of income they’re hoping for. So it’s important to be proactive and do more yourself to help you achieve your retirement goal.
The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice. If you’re not sure about investing, seek independent advice.
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