Mind games – Why we can’t save
Estelle Scholtz-Mare, Head of Momentum Retail Financial Planning and Financial Wellness Marketing for Momentum.
July is savings month and if statistics are anything to go by, most people mutter “savings, what savings?” when they see messages espousing the merits of feeding a piggy bank. There is a collective feeling of guilt when you talk to South Africans about their savings plans. They know they need to save, or save more- but despite the best of intentions, a health nest egg eludes them.
It is cold comfort to know that this is a global phenomenon but on the scale of bad to awful, we find ourselves occupying the lowest rungs of the ladder; saving less than 2% of our incomes. So why does this happen? To get some answers we need to visit the subject of behavioural economics. There are literally thousands of studies dedicated to understanding why people don’t save and they have some interesting answers.
The big challenge in human decision-making is our inability to follow through on our intentions, because life gets in the way. There's often a huge (what experts call) “action implementation/planning gap”; we plan to do the right thing but we just don't get down to doing it.
When it comes to making the decision to save, the process is a simple equation: you look at the present net value of your future income stream, coupled with the estimated present net value of your future consumption stream, and then you set your savings decision such that the present value of those two numbers is the same.
The tricky part is estimating the variables. How long will you live? How many kids will you have? What lifestyle will you live? How much money will you spend on holidays and accommodation?
Then we have to make a call on the economy, because this will dictate interest rates and growth on capital markets- ultimately affecting the returns on investments. An economist would be hard pressed to estimate these variables accurately, an amateur economist would find it impossible. It is little wonder that people shy away from saving, there is simply too much information to process, and when people are faced with information overload, they tend to avoid making decisions.
Even those who are prepared to do the maths and/ or get the help of a financial advisor, get side tracked. There is a massive amount of complex decisions and influencers that we need to deal with daily. Purchase decisions, kids demanding attention, workloads, medical issues, transport and relationships, all compete for our attention. We have a limited capacity to deal with multiple sources of stimuli, and this is why we rarely pick up all of the information that's necessary to make a good financial decision.
Estelle Scholtz-Mare, Head of Momentum Retail Financial Planning and Financial Wellness Marketing for Momentum says “We are constantly battling ‘should vs. want’ decisions. We “should” save but we also “want” the new cell phone or our weekend entertainment. It is not that people don’t know what they should be doing; they simply behave in a seemingly irrational manner when faced with an appealing purchase opportunity”.
Richard Thaler (Author of Nudge) and Hersh Shefrin, renowned researchers in this field explain that we have duel elements to our processing systems; the ‘planner’ and the ‘doer’. The planner is foresighted, realises the consequences of current decisions and hence charts out an optimal path. The doer, on the other hand, lives in the moment and is myopic, and pushes for the action that gives them the greatest value in the present.
According Dilip Soman, Professor of Marketing and a senior fellow of the Desautels Centre for Integrative Thinking at the Rotman School of Management, in Thaler and Shefrin’s model, the planner controls the doer’s desire through willpower. In general, the model suggests that when people are asked about their preferences, their planner comes forth and they respond with a “should” option. However, when they are faced with a tempting purchase opportunity, the doer comes forth and pushes the individual towards the want option.
“This is just scratching the surface of human decision behaviour but the bottom line is that if we are to stick to our plans of saving, we need to implement mechanisms that will circumvent our lack of willpower,” continues Scholtz-Mare. “For example, setting up a debit order on our current account for a savings plan, or using envelopes to keep our entertainment money in, so we don’t overspend. Using a financial advisor can also help because they form a barrier between you and your money which should stop an impulsive withdrawal from funds.”
By becoming aware of these decision traps, it is much easier for an individual to keep on track. The gremlins are much easier to tackle if they are visible and top of mind. So people should not beat themselves up for dropping the ball, they just need to understand the dynamics of what caused the ball to slip through their fingers.
“This savings month, people should not just make the decision to save, they should look for aids that will help them to stick to their plan,” concludes Scholtz-Mare.
