Updated: May 3
The Power of Habit by Charles Duhigg is a fantastic book that helps us understand why we make so many choices throughout the day. If you’ve ever tried and failed to quit smoking, eat healthily or stick to a budget, don’t beat yourself up. Habits have tremendous power over our decision making.
In this article, I’m going to review lessons from the “Power of Habit” that you can easily apply in your own life to create better financial habits.
How habits are formed
The key to creating good habits is to understand how habits are formed and use that knowledge to break bad habits and replace them with better ones. Habits have served a necessary evolutionary role. They allow us to get things done without straining the brain.
Take the simple act of walking up a flight of stairs. How mentally draining would it be if we had to stop and think about how to walk up every staircase we come across? Luckily we have formed a powerful habit that allows us to walk up a staircase without giving it a second thought.
Eventually, even complicated actions like entering out spending into an expense tracker can become an effortless habit.
Habits are formed using a three-part loop.
You sense an external cue.
You perform a routine that you associate with the external cue.
You get a reward.
If you wanted to create a habit of tracking your spending every single day, you might consider creating a three-part loop to achieve that goal.
Set an alarm on your phone that goes off at the same time every day.
When the alarm goes off, you drop what you’re doing and input all of the days spending into an expense tracker.
You get a reward. In this case, it might be a feeling of satisfaction and success.
When the alarm goes off it creates a spike in brain activity as your brain recognizes the sound and decides which habit is most appropriate in response to the external cue.
Then you instinctively begin the process of tallying up all the purchases you made that day and inputting them into your expense tracker. Once the habit is fully formed, your brain can be basically on autopilot while you perform this routine.
Your brain activity spikes again when it registers the successful completion of this important task. This helps reinforce the connection between the external cue (the alarm) and the routine of tracking your spending.
Habits create craving
The third part of the habit-loop, receiving a reward is what makes habits so powerful. Your brain begins to crave that reward. This is what makes breaking bad habits so difficult. If during every workday, you decided to go out for lunch you eventually create a habit.
You experience an external cue in your lunch break.
You perform a routine in going out to lunch.
You get a reward when you eat the delicious food that has been prepared for you.
Even if you have decided to pack your lunch and bring it to work every day, it may not be so simple. Your brain is still craving the habit of going out to lunch.
You can have the best intentions in the world of saving money by cutting back on spending, but to do that, you need to break the bad habit of paying for lunch every day.
Break a bad habit by swapping it for a better one
To break the habit of paying for lunch every day, it makes sense to replace it with a better habit like bringing your lunch to work every day. You might start by listing out what exactly you crave from eating out at lunchtime. For many people, what they really crave is the companionship of going out for lunch with a friend or co-worker.
If companionship is what you crave, you should set up a new routine that satisfies that craving. Talk to a group of co-workers and ask them to consider making a pact to also pack their lunch and eat together in the cafeteria. This can satisfy the craving for companionship and creates a new habit of saving money.
Breaking any habit is a two-step process.
Identifying the craving associated with the bad habit.
Find a new habit that both satisfies that craving and moves you closer towards your goals and ideal outcome.
The power of small wins
In his book, Duhigg describes what he calls “keystone habits” which have positive effects in other areas of our lives. Keystone habits are small actions that are easy to achieve. These achievements provide us small wins and help us make more broad changes in our life.
If you have $50,000 in debt spread over four different credit cards it would be a daunting task to pay off that debt. It requires you to completely change your lifestyle and how you manage money.
However, if you focus on a keystone habit like tracking your spending, you get a small “win” every time you find expenses you can cut.
This builds confidence and pretty soon it spills into other areas of your life. Maybe you take that extra money and you pay off one of your credit cards.
One win leads to the next action which leads to another win. This creates a virtuous cycle and over time the $50,000 in credit card debt is paid off. It all started with the small wins provided by a keystone habit.
If you want to make broad changes to the way you manage money, identify and develop a keystone habit that can quickly provide you with some small wins.
The power of financial habits
Habits are incredibly powerful and influence human behavior.
Habits are formed through a three-step loop.
Receiving a reward.
The reason habits are so powerful is because they create cravings.
If you identify a bad money habit, start by asking identifying which cravings are associated with that habit. Then, find a new habit or routine that satisfies that craving but moves you closer to your financial goals.
Broad, sweeping changes like paying off all your debt can be intimidating. By developing keystone habits like tracking your spending can provide you with small wins early on.
These small wins can give you confidence and encourage you to find more small wins. Over time, these small wins add up and have the power to change your relationship with money.
If you're ready to master your money, don't forget to enroll in my video-based personal finance course, "Millionaire In The Making: The 30-Day blueprint" Click here to enroll.
What are some bad money habits you would like to break? How have you found success in creating good money habits? Let me know in the comments.