Some years ago now, I was a lowly article clerk earning a lowly salary.
During that lowly-paid time, part of my contract terms included an automatic 12.5% contribution to a Provident Fund. I could elect for that amount to be higher – but never lower. And I became relatively famous (at least, I thought so) for making the following argument:
- Principle: I ought to maximise my quality of life.
- Fact/Observation: 12.5% of a small salary today has a much greater impact on my quality of life than 20% of a higher salary when I “start reaching my full earnings potential”.
- Conclusion: I should be allowed to opt out of this absurdness. Come now.
So when I left my articles time behind me, I was first in line to cash in that provident fund in order to “maximise my quality of life”. And when I say “first-in-line”, I really do mean that: those forms were submitted alongside my resignation letter.
Whether or not that was the right decision, I can point out some psychological impulses that helped me make it:
- A desire to be instantly gratified
- A belief in my ability to be self-restrained in the years of “my full earnings potential”.
I was also guilty of an arithmetical bias (an inability to see the cumulative compounding effect of small sacrifices, which I wrote about here: “Have you really done the math?“).
I have since listened to a Richard Thaler lecture
Richard Thaler is one of the pioneers of behavioural economics – a field that combines psychology and economic observation. And for the record, he is a highly entertaining speaker – if you’re looking for a way to utilise your time spent in traffic, you should have him on your playlist.
What We Should Know About the Way We (Don’t) Save
- We are much better about saving in the future than we are today. It’s like going on a diet: we’re always going to start dieting tomorrow; today, there is the slice of chocolate cake that my mother made, and it would be rude not to have a slice.
- We are loss-averse. Which means that we hate giving things up that we think we already have. An example: I’m more likely to resist the chocolate cake if my mother offers to go to the shop and get me a slice than if she sets the cake down in front of me.
- Inertia. Having also read “The Power of Habit” by Charles Duhigg, I might also call this our ability to fall into routines which are difficult to change. In the chocolate cake example – if I always expect to have a slice when I go to my mother’s, it’s even harder to say no. Because my body is already anticipating the chocolate deliciousness.
- We don’t know how much to save. Do you save R300? Do you save R3000? What is too little? It’s all too much calculating effort.
So there are some issues to be overcome
The Thaler/Bernatzi Solution: Save More Tomorrow™
The Thaler/Bernatzi solution was to use the above “negatives” to help in the saving process.
Here is the story of their experiment:
- They found some companies to participate in the experiment.
- They had management approach their employees three months prior to year-end, (so three months before the employees would normally receive their annual increases).
- Management then invited their employees to commit to an increase in their savings rate (ie. increase the percentage of their salary that they’re contributing to their retirement savings plan) in three months’ time, and also to commit to the same level of increase every time they would receive a future raise.
- The employees were allowed to opt out of the commitment at any time.
So to backtrack a moment, when these employees were first approached about increasing their savings rate immediately, 72% of the staff opted to keep things the same.
But when they were given the in-three-months-time option, 78% committed to the change. And 98% of those employees stuck with the plan through two future pay-rises (ie. they increased their savings rate every time they got a raise). And even then, the people that eventually opted out didn’t go back to their initial savings rate – they just didn’t want the savings rate to increase any more.
In the end, over the 28 month experiment period, the average savings rate of the employees went from 3.5% to 11.6%.
What We Should Take From This
When you look at the reasons why the Save More Tomorrow™ plan worked, you’ll notice that:
- Because the commitment took place in advance, there was no present cost or loss for the employees.
- Because the employees were committing to save money that they were still to receive, they didn’t yet have the sense of entitlement (ie. it didn’t even feel like they had to give something up in the future).
- And because they had the option to opt out (rather than to opt in), it meant that they would have to go through the administrative process of contacting people and filling in forms in order to change the status quo.
- That is: the proposed solution used their own laziness (or “inertia”) in their favour.
In practical terms, what that means is:
- Before you get your next raise, call your broker/unit trust of choice, and set up a debit order.
- You only need to do it once.
- Because firstly, you’ll probably be too lazy to ever change it.
- And secondly, you won’t really notice the impact (because the money will be out of your account before you even realise that it was there in the first place).
And in South Africa, we have fun things like Tax-Free Savings Accounts. And if you want to get a feel for the impact that a monthly debit order can have, go and have a play around with this neat calculator from savetaxfree.co.za. I’m a massive fan.
Finally, don’t stress too much about feeling lazy. Because if you manage it correctly and call it “inertia”, then it can become a very good thing.