Figuring out how much to save for the future is no easy task — and the fact that many of us will now live to be 100 makes it even harder. There are so many contingencies to consider: unforeseen medical expenses, childcare expenses and changes to your income. When you add in stock market risk and economic shifts, it really is a complex scenario.

Given this complexity, rather than doing the hard work and research, people tend to engage in social learning. They might just ask their friends what they are doing, listen to experts on the radio or read personal-finance magazines and follow the norms that they come across. The hope, of course, is that these people have thought hard about it and made wise decisions, and that we can just go for a free ride on that information. This doesn’t just happen with personal finance choices. Whenever we don’t know what to do in life or a situation is too complex to analyze, we look for mental shortcuts. We look around to see what people around us are doing, and we often follow that.

What are some of the most common biases in the realm of personal finance and spending?

As indicated, social norms are extremely powerful. The problem is, there is very often a selection bias in the sample that we have chosen to observe. For example, we tend to focus more on salient behaviour, and we neglect that there are other behaviours that are not as visible to us.

Of course, there are lots of other biases when it comes to personal finance. One very common one is overconfidence. With respect to our finances — and many other areas of life — we believe that our ability to do something is far better than it actually is. Another common bias to keep in mind is that people often make time-inconsistent decisions. The literature calls this hyperbolic discounting, and it describes the tendency for people to increasingly choose a smaller-sooner reward over a larger-later reward as the delay occurs sooner rather than later in time. Basically, we will take a smaller reward today over a bigger reward next week. But our preference for the more immediate reward diminishes as it moves further away in time.

It’s almost like we have two selves: One looks at near-term interests, and the other takes a longer-term perspective. And sometimes we listen to one self more than the other, depending on contextual factors like the framing of the question or the offering.

Advances in technology from the Internet to social media have dramatically reduced the cost of conveying information about consumption activities. How has this affected personal consumption?

This was the main motivation for my recent research. My co-authors — University of California, Irvine professor David Hirshleifer and UC Berkeley professor Johan Walden — and I were trying to explain a very troubling fact: In developed countries, the personal-savings ratio has steadily declined over the last 30 years.

In developed countries, the personal savings rate has steadily declined over the last 30 years.

We noted that, at the same time, there have been significant advances in technology in that timeframe. Even before the Internet we had cable TV, with the Home Shopping Network, HGTV and other channels showcasing fancy travel locations and lifestyles. Then came the internet and social media. Today, people everywhere can easily showcase all the good times they are having through consumption. I mentioned earlier that we don’t tend to notice what we don’t see. Most people don’t post about mediocre or sad life events. They only post if they go to a fancy restaurant tor a sunny beach, because they want to present a positive image of themselves. So there has been this tendency to make consumption activity much more obvious than it ever was in the past.

Of course, businesses and financial institutions love this, because they want us to spend more. And if you don’t have enough money, don’t worry — here is some credit! As long as there is a chance you can eventually pay it back, they will promote this culture.

It goes back to simple selection bias. Let’s say a few of your friends post on social media about taking a vacation in January. In fact, many more of your friends did not take a vacation in January. But they aren’t posting about that. If you neglect this, you will always feel like everyone is doing something exciting. It might only be three out of your circle of 20 friends doing it, but because you only see posts from those three, you feel like, maybe I should consider take a vacation, too. The bottom line is that technology and social media are promoting consumption more and more, and people are saving less and less.

Tell us a bit more about selection bias.

In behavioural economics, selection neglect is closely related to the availability heuristic. This is a mental shortcut that relies on immediate examples that come to a person’s mind when evaluating a specific topic, concept or decision. If I ask you what the likelihood is of something happening, and you can easily recall it in your memory, you will perceive a higher likelihood of that event happening. If you cannot recall such a thing, you will think it is unlikely to happen.

Whenever we are exposed, even subtly, to a consumption activity, we automatically think that the population is doing that activity more than what the reality is. It’s like comparing what you can see versus the dog that didn’t bark’: What we see and what we don’t see have a different influence on our perception. Saving and investing activities are rather private. You log into your bank online, balance your cheque book, think about investing and set up an appointment with your advisor. Importantly, no one sees any of this behaviour. Whereas the opposite is true of consumption activity.

This visability bias carries over to the realm of stereotypes. If we see some cases of a certain group of people doing certain things — say, driving poorly or getting upset easily — we tend to assume that all people from that group behave that way. In truth, that is probably not the case at all. We need to be very wary of small samples, because too often we extrapolate from the few to the many. This is also called the law of small numbers.

Your model implies that degree of urbanization is negatively related to personal savings rates. Please explain.

Here’s an example of why that is. I moved to Toronto recently from Austin, Texas — from a smaller city to a bigger city. In Toronto, it seems to me like everyone has a lot of disposable income, even though when I look at the statistics, I see that this is not the case. The reason I feel like people have so much money is that in a big city we live closer together, so I can easily observe what people are doing from day to day.

In Texas, the smallest lot is around one acre in size, so my neighbours were quite far away. There was much less chance of observing them or talking to them about what they are up to. Urban population density increases the intensity of social interaction. It’s all about how observable your neighbour’s activities — including consumption — are to you. If you don’t observe them, you won’t be affected by the visibility bias. Likewise, if you don’t have a Facebook account, you won’t be affected by visibility bias. It’s only when you can easily observe what others are posting and doing that it becomes a problem.

We need to be wary of small samples, because too often we extrapolate from the few to the many.

Would you go so far as to say that people who stay away from social media are likely to be better savers?

Yes, I think so. When you don’t know about what others are doing (and consuming) you can go about your life without social pressure. Of course, then you miss out on the benefits of social media. For example, in some cases, there is useful information to be had in learning from others, and there is social capital to be gained.

What policy interventions do you recommend to combat overconsumption?

We don’t need to ban social media. But perhaps some authority, like Statistics Canada, could come out with reports about what people are actually spending their money on, and how much. They have these numbers; they could just make them widely available.

Pluralistic ignorance is one name for what I’ve been describing — when our beliefs about other people’s behaviour are different from the truth. If you ask college kids, How many of your peers go out drinking every night of the week?, many perceive that the number is very high. But actually, it’s only a small minority. If everyone knew that only three per cent of college students consume alcohol every day, students would feel a lot less pressure to follow suit.

As I have indicated, it’s the same with consumption. We overestimate how much our neighbours or the population is consuming and we underestimate how much they are saving. I think reporting on the truth could help. We could also use behavioural cues to unbias the tilt towards paying attention to consumption. For instance, maybe we could make all the unseen behaviour (i.e. saving money, studying) somehow more obvious and available to people.

Perhaps the big banks could start running ads showing young people staying home to study, dreaming about their future success?

That is kind of what we are saying. The problem is, the banks wouldn’t have any incentive to do that, because they want people to consume and borrow money. But there are other people and sources who could get these messages out. Various leaders and organizations could come out publicly to preach in favour of thrift and to criticize our desire for instant gratification.