What is the Best way to Save; Is it Today or Tomorrow?
March 29, 2016 - 4 minutes read
Posted by Claire Parker
Most of us see ourselves as rational. And indeed we are, most of the time. A brief self-examination will conclude that no one is perfect but when it comes to the big issues that directly affect our lives, we will give them some thought and put in the necessary actions to keep ourselves on the right path.
The checks and balances that we do during our daily routines naturally pick up on anything that might cause us problems or help us in the future. Or at least you would hope so. The human behaviour of even the brightest minds among us can be surprisingly illogical and when it comes to money and there are some great examples of how. Daniel Kahneman in 2011 wrote a very famous book that shows that we aren’t always logical. Have a go at some of the questions for a bit of fun.
Perceptions of Risk – Present and Future
When the perception of time and money come into play, typical behaviours around mortgages can start to give us clues about how we take more risks when instant gratification is on the cards. When borrowing is available, many buyers will push themselves to get a mortgage for the most expensive house they can possibly afford, yet it is common that many of these households will not have taken adequate life insurance to cover those who live in it.
More often than not this can be seen as a minor detail that can be sorted out in the future. The main thing is that they have what they need today. So when the idea of saving arises this is often given the same treatment while at the same time the average Brit will spend £416 on lottery and scratch cards a year. Many of us will even go to the trouble of insuring our smartphones before saving for the future.
Loss Aversion and Instant Gratification
Instant gratification Vs self-control is a struggle between the present and future that most of us are familiar with. And there have been some great studies that manage to simplify the psychology around our behaviours when it comes to money. Research by Richard Thaler and Shlomo Benartzi came up with a method to actually profit from our ability to be unconcerned about the future with something called “Save More Tomorrow”. Amazingly, I have been using this myself without knowing about this for some time now.
See the Ted Talks Video Here
This study showed that even though savings are clearly there for us to benefit from in the future, it is common for many to feel physical loss by putting money aside with a misplaced tendency to overvalue immediate gains. Those without savings regularly find the idea of things like having Sky TV and the latest Iphone more appealing than having savings in the future. This is why the financial media loves to show statistics that as a “millennial” I am not saving enough for the future.
What if there was another way?
How to implement “Save more Tomorrow”
The Save More Tomorrow study found a common ground to deal with these preconceptions of loss in the present by suggesting a saving plan that took a certain amount from future raises in income as and when they happened. This would mean that the saver does not have to endure any cuts in expenditure and they can stay within their comfort zone of planning to put money aside in the future rather than in the present.
Millennials are particularly affected by a sense of loss aversion in the present when it comes to savings. With the average salary for this age group still below early credit crunch levels and student fees in the region of £40K before even starting a job, putting off saving to sometime in the future is all too easy. But even at this most financially challenging time, the Save More Tomorrow method of forecasting salary increases over the years, with commitments to saving part of these raises when they occur has proven to be a popular strategy that works. In short the method is relying on putting more of your future income increases (such as a pay rise) towards your savings pot. I.e. you get paid more, you pay more into your savings or pay down debt.
Automation Is Key
On a final note, if you think this could be helpful to you or someone you know one last detail to bear in mind could make all the difference. Automation is key. If today you received a pay rise and you remembered to put part of it away you will find yourself under the same psychological pressures that this method has sought to avoid. Loss aversion and present bias will always arise if you attempt to abstain from money that you have today. If you arrange with your company to automatically pay an amount of future increases into your savings, you will find this to be the path of least resistance. In time, we never know, there may even be tools and investment solutions that already do this for us like in the US.