One of the hardest things for many people to do is save. Too many things get in the way and nobody really wants you to save anyway. Temptation is everywhere, the reasons for giving in are huge and the reward in this low-interest rate climate is non-existent.
It’s much more fun to buy a bigger home, renovate an old one, upgrade the kitchen and bathroom, borrow to invest, or buy an expensive toy. Its no surprise then that savings rates are at historic lows and household debt at record highs.
While everyone agrees it’s not a healthy picture, is there anything that can be done? Is it realistic to expect people to fight the urge to splurge when there’s no incentive to save?
A recent Toronto conference, sponsored by the non-profit Public Policy Forum, looked at how to encourage people to save more for retirement. One discussion tackled the psychological origins of undersaving, where David Laibson a Harvard behavioral economist, offered plenty of examples of the problem along with some possible solutions.
Behavioral economics nudges people to make the right decision and can be applied to exercising at the gym or saving for retirement. The nudge persuades you to act, while an escape hatch gives you a psychological out. Researchers find that when people are nudged to join retirement plans with an opt-out clause, they usually stay put.
The British supplementary pension plan NEST launched in 2012 is a good example. When ramped up, NEST will force 9 million Britons without a company pension to enroll. The automatic signup (the nudge) comes with a quick opt out if you so choose. So far, only 8 per cent have done so, mostly those nearing retirement who have little to gain from the plan.
Laibson said in the U.S. where employees have been automatically enrolled in company pension plans with an opt-out provision they also tend to stay.
The theory also explains why joining a gym (a good thing) doesn’t necessarily lead to more exercise. Studies have shown that many people join with good intentions, but few actually go. But getting a trainer (the nudge) can change that.
“If we have self control problems, what we need is a commitment contract,” Laibson said.
Laibson says the problem lies in our bias toward doing things that have an immediate payoff. Even though we have good intentions and know what we should do, we find it hard to act in our best interest. The lure of the present is more powerful than a reward in the future.
“We are patient about choices made for the future, but impatient for those today,” Laibson said. “Immediate events get full weight. Everything else gets half weight.”
He cited a Dutch study where a group was asked to choose a snack for a meeting next week. The choice was fruit or chocolate. Seventy-four per cent chose fruit. A week later the group was told the selections had been lost and to choose again for that day’s snack. Seventy per cent chose chocolate.
In another study, researchers asked 100 people about their saving habits. Sixty-eight agreed they were saving too little and 24 promised to increase their savings within two months. Four months later, three people had followed through.
These findings explain why running buddies, personal trainers and financial advisors help. They create structure and provide a focus that keeps the target in sight, whether it’s training for a half marathon or putting together a down payment for a house.
“They force tomorrow’s self to do what today’s self isn’t willing to do, by nudging them to do the right thing,” Laibson said.
November is Financial Literacy Month in Canada and you’ll be hearing a lot about the lack of it. Plenty of people will be trying to nudge you toward better financial behavior.
The best and easiest way to start saving painlessly, is through payroll deduction. It’s hard to miss money you don’t see and it’s surprising how quickly the savings add up. It’s a good habit and forces you to be disciplined.
Your employer can help set up a deduction that directs a portion of your paycheque into a bank account, Tax Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP). If you get a raise, take part of it and increase your deduction.
Or go online and set up a recurring transfer to a savings or investing account. Financial literacy is ultimately about spending less than you make, saving the rest and investing patiently.
It’s not complicated; you just have to get going. The focus on financial literacy this month may just be the nudge you need.