Not so long ago, I was a lowly article clerk earning a lowly salary. Of course – I still feel like I sit in the “lowly salary” segment – but then, much as now, it was because my idea of “life” involved going to awesome restaurants* and being able to buy climbing shoes because I’d decided to take up wall-climbing that week. Which is beside the point – except perhaps to emphasize my slightly-twisted embrace of the carpe diem principle.

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 (in my eyes) for making the following argument:

  1. Principle: I ought to maximise my quality of life.
  2. Fact: 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” (ie. I can make up for it later with less impact).
  3. Conclusion: I should be allowed to opt out of this absurdness. Honestly.

So when I left my articles time behind me, I was first in line to cash in that provident fund and use it to continue “maximising my quality of life”. Whether or not that was the right decision (for me), 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 (please read this post: “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.

Here are some links:

  1. His paper, co-authored with Shlomo Bernatzi, on employee savings.
  2. A podcast of his lecture at the LSE.

What We Should Know About the Way We (Don’t) Save

  1. We are much better about saving in the future than we are today. It’s like going on a diet – we’ll always start dieting tomorrow – today, there is the slice of chocolate cake that mom made, and it would be rude not to have a slice.
  2. 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.
  3. Inertia. Having also just read “The Power of Habit” by Charles Duhigg (it definitely needs a post all of its own), I might also call this our ability to fall into routines/patterns which are then difficult to change. To go back to 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 goodness.
  4. 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.

And this is actually quite concerning in a lot of ways. Especially because many employees will no longer have defined benefit retirement plans – which is more significant that it sounds.

Under a defined benefit plan, a company would have taken some of your salary each month, added in an equal amount of its own money, and put it into the company’s pension fund on your behalf. You would then have been entitled to a pension of a certain amount (ie. your benefit was defined as your pension) – and if the company’s pension fund hadn’t performed as well as it needed to, then the company was obligated to put more money into the fund in order to make sure that you get your defined benefit. From the company perspective, this was all a bit awkies: uncertain cash flows and the like.

As a result, there has been a dramatic shift away from defined benefit plans into defined contribution plans.

Under this approach, the company defines how much money it will contribute into a fund of your choosing (hence: “defined contribution”), and you get to decide how much money you’ll contribute/save as well. Which means that you no longer have the same guarantees that your parents/grandparents had; and it also means that a lot more of the control now rests with you, under the influence of all the biases and the consequent procrastination.

The Saving Solution: Save More Tomorrow™

The Thaler/Bernatzi solution was to use the above “negatives” to saving in a fairly transformative way. Here is the theory:

  1. Find a company that will participate in the experiment.
  2. Approach employees three months before they expect to receive a raise.
  3. Ask them to commit to an increase in their savings rate (ie. increase the percentage of their salary that they’re contributing to their defined contribution plan) in three months’ time, and to the same level of increase every time they get a future raise.
  4. Allow them the option to opt out at any time.

When these employees were first approached about just increasing their savings rate based on their current salaries, 72% of the staff opted to keep things the same. But when they were given the three month’s time option, 78% committed to the change. Furthermore, 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 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 I look at the reasons why the Save More Tomorrow™ plan worked, I see the following:

  1. Because the commitment took place in advance, there was no present cost or loss for the employees.
  2. 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).
  3. Because they had the option to opt out, it meant that they had to go through the administrative process of contacting people and filling in forms in order to change the status quo (just contrast this to the option to opt in). It used their own inertia in their favour.

In many ways, it gives me faith in South African law, which already caters for the fact that we procrastinate by enforcing some kind of savings regime through compulsory retirement contributions.

But here is what everyone should be doing anyway:

  1. Before you get your next raise, call your broker/unit trust of choice, and set up a debit order.
  2. You only need to do it once.
  3. Then you’ll be unlikely to ever change it.
  4. And you won’t even really notice it, because the money will be out of your account before you realise that it was there in the first place.

Incidentally – I invested my Provident Fund payout almost as soon as I got it. Oh – it wasn’t a traditional investment: it was in the art/antique/valuable-book class of asset.

So I think that the moral of my story is: only cash in your provident fund if you find something more awesome to invest in.

And don’t stress about feeling lazy. Sometimes, if you manage it correctly and call it “inertia”, it’s a good thing.

*Incidentally, I’ve since come to realise that I have this absurd expectation that everything I eat should be delicious, otherwise it’s just a waste. Which, if I was looking for a reason behind unexpected weight-gain, seems like the obvious answer. That is – I can handle about one bowl of plain Bulgarian yogurt before I’m “full, thanks”. But bowls of custardy warmth can go on for ages. Also, like, who knows when I’ll be able to eat custard again? #InstantGratification

**Maybe it’s just me – but every so often, there is a small section of a chapter in a book that radically shifts my paradigm. Something that instantly becomes part of my intuition – like belief at first sight. And this discrepancy between logarithmic and arithmetical thought (which I talk about in that post) was, for me, one of the more profound moments.

***Today, that link seems somewhat self-evident. Economics is the study of human behaviour. Human behaviour is psychologically-motivated. Ergo… Yet somehow, up to the 1970s/1980s – economics was a “science” that made observations “empirically” and built mathematical models to explain economic behaviour, on the assumption that almost everyone fits “the rational man” mould.