And so 2014 is upon us. Amongst all those resolutions, it is common to have one about finances, especially an intention to save more. But alas, common with resolutions made on many different subjects (health, education, family, lifestyle etc), it often proves hard to implement.
Procrastination in savings decisions is all around us. A well-cited piece of academic research is illuminating. In 2001, James Choi and colleagues surveyed staff at a large US firm. Most of those interviewed (68% of respondents) reported that their current savings rate was ‘too low’ relative to their ideal rate. Meanwhile, 24% said that they intended to save more by making additional contributions to their pension plans. The researchers then found that only 3% of respondents actually followed through and increased their level of contributions.
There has been much research into the causes of such procrastination. Reasons include anxiety, not knowing where to start, complexity, the fear of failure, perfectionism, and disorganisation. When it comes to procrastination around financial decisions, and particularly the decision to save more, there are fewer reasons to focus on:
- Myopia and bounded rationality – many people are extremely short-term focussed and put greater weight on what can be enjoyed now rather than what can be saved for and then enjoyed later. In the research literature this is known as hyperbolic discounting and was first proposed by well-known psychologist researchers Kahneman and Tversky in 1979. There is also bounded self-control: the limited willpower of people to execute their plans.
- Complexity – complex decisions tend to be deferred for two reasons. One is that people are anxious about making an incorrect decision. The other is hesitating to commit to the work required to make an informed decision or indeed not knowing where to start. In subsequent research Choi and colleagues found clear evidence that complexity of financial decisions can lead to procrastination.
- Status quo bias and inertia – people may realise that they should change how they act but feel comfortable or trapped in their current behaviour. This effect is magnified if the upfront commitment or effort feels significant. As an example of how this can be overcome in practice, consider how easy weight-loss programmes are to sign up to, generally a simple toll-free phone call.
When it comes to increasing savings, how then can we overcome procrastination? Although not all households are in a position to save more, many are and probably should save more if they wish to avoid a deteriorating lifestyle when retirement arrives.
There are ways in which the industry can help overcome some of these road blocks, and here are a couple of case studies:
- In a 2012 paper the economist Felipe Kast and colleagues conducted some savings experiments amongst micro-entrepreneurs in Chile. In the first experiment they created self-help peer groups to encourage individuals to stay on track with their savings plans. Savings activities (frequency and amount of deposits) were discussed at group meetings. Those who were involved in the group made 3.5 times as many deposits and saved twice as much as the control group (who also said they wanted to save more but were not assigned to a self-help group). This type of result may not surprise – consider the positive influence of peer groups in areas such as fitness, weight-loss and alcohol abuse.
In the second experiment the researchers replaced the peer group model with a programme of simple text message reminders. This was also successful, about 80% as successful as the peer group model.
- In 2004, the researchers Richard Thaler and Shlomo Benartzi created a savings programme in the US entitled “Save More Tomorrow”, which was subsequently patented and given the trademarked acronym “SMarT”. This programme was designed to increase the member contribution rates to pension funds and has been successfully rolled out (now via the authors’ relationship with Allianz) across many pension funds worldwide.
The essence of the SMarT programme is that plan members pre-commit to allocate a large portion of any future pay rises to increasing their contribution rate. There are three important steps to SMarT that can nearly be thought of as behavioural ‘tricks’.
Firstly, members pre-commit to increasing contribution levels well before they receive any pay rises. This means there is no immediate pain or change in consumption levels, thus getting around some of the myopia and bounded rationality issues discussed above.
Secondly by pre-committing the status quo position is now reversed. Their starting point is that they are a member of the SMarT programme and, while they can exit whenever they like, they tend not to.
Finally because the increased savings levels are funded out of pay rises, they do not anticipate a reduction in income and lifestyle changes (ie remove the issue of loss aversion). Note however that they probably will in reality experience some impact on lifestyle, because pay rises usually partly offset inflation.
The SMarT programme has been extremely successful. In the first example, rolled out across employees of a mid-sized US manufacturing firm, 80% of those who signed up remained in it until the fourth annual pay rise, and their contribution rates rose from 3.5% to 13.6%.
These types of solutions, which help create savings discipline, have applications across the financial planning and the superannuation industries. Perhaps similar models exist already but I have not come across them in Australia. Indeed the opportunity for super funds is obvious: why wait until beyond 2020 to lift member contribution rates to 12% when most of the industry already acknowledges that 12% plus is an appropriate rate?
I also expect that savings club structures could even create greater association with the super fund itself. This is all part of the bigger issue of how far the role of a super fund extends. Surely there is a strong argument that helping members to work around known behavioural biases would be a valuable benefit.
Of course, it goes without saying that I would have written this article sooner, but…
David Bell’s independent advisory business is St Davids Rd Advisory. David is working towards a PhD at University of NSW.