Let’s start with the first: getting capital to start with. Unless you win the lotto or come into a windfall, for most people this will mean saving money.
The best way to save money is to automate the process as much as possible.
Most of us know that at some level we have self-control issues, but we underestimate the extent. We think we can have just one potato chip but end up eating the whole packet. We think that we can cut back on unnecessary expenses but then we run up credit card debt. We think we can save part of our pay check every month but then we end up spending all of it.
When it comes to our actions, our intentions and what we do are often quite different.
The behavioural economist George Loewenstein (1996) calls this the “hot-cold empathy gap. What we do in a “hot” scenario is different from what we do in a “cold” scenario. Ask someone who has resolved to exercise every day at lunch what they are doing Friday lunch and they will most likely tell you that they are going to the gym. Come Friday when they walk past a restaurant with yummy smells, the sight of old wines and a group of good friends that they know, and it won’t take much convincing to stop for lunch rather than hit the gym. The “cold” scenario is the planning scenario where temptations are not right in front of you. The “hot” scenario is at the restaurant in this case where the short-term fulfillment becomes more important than the longer term goals of exercise. The “hot-cold empathy gap” is the difference between what we plan to do in “cold” scenarios vs what we do in “hot” scenarios.
Self-control problems can be helped in understanding there’s a far sighted “planner” and a near sighted “doer” within all of us. The planner will try to work towards your long-term goals, but the doer wants to be satisfied with the temptations of instant gratification. The key to self-control issues is to help the planner by putting processes in place so that your long-term goals are achieved.
That’s where regular savings plans or automatic transfers of money from transaction accounts into investment accounts and reinvestment plans can be so powerful. By setting aside an automated payment into an account that is difficult to access, we can bypass some of the self-control issues which can be a barrier to creating wealth even if the planner in us doesn’t intend that to be the case.