PARADE Magazine | How To Save Smarter
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How To Save Smarter
by Tim Harford
published: 05/10/2009
Not very long ago, Americans were terrible savers. In 2007, the average person
put aside 60 cents of every $100, or .6% per paycheck. However, the current
economic downturn has shocked us into depositing more at the bank. As of
February, the personal savings rate was more than 4%. That’s a big improvement,
but it’s still half of 1980s levels, when Americans routinely socked away 10% of
their paychecks. Why is saving so hard? And how can we be smarter savers?
Behavioral economists—researchers who mix psychology and economics—have
uncovered three reasons why people find it so difficult to save. The first is
temptation: Although we often later regret it, we just can’t resist spending. The
second is lack of understanding: Our brains can’t quite grasp the profitability of
saving. The third is optimism: We believe that everything will work out, even if we
don’t save.
Fortunately, researchers have found solutions to these problems. Temptation can
be countered if you make saving as much fun as spending. This isn’t such a
stretch. Neuroeconomist Ben Seymour of University College, London, sits in front
of a brain scanner and watches what happens in our heads when we think about financial decisions. He found that imagining a future purchase is almost as good
as getting it. For example, when we daydream about buying a new car, our brains respond in much the same way as when we actually make the purchase.
We can harness this buzz to our benefit by discarding vague ideas of “saving for a rainy day” and focusing instead on particular items we need or want. “Saving
is much easier when it’s for something specific,” Seymour says. Reinforce this connection in your mind by opening a different savings account devoted to each
of your goals: one for a new car, one for a vacation, one for a child’s college tuition fees.
Or try this effective technique: Remind yourself to save whenever your paycheck comes. Write messages in your calendar or set up your computer or e-mail
program to give you periodic prompts. Dean Karlan, an economist at Yale, has tested this method in experiments in countries such as the Philippines and
Bolivia. He discovered that even low-income bank customers managed to deposit some of their wages when they were nudged to do so by regular text
messages. “That beats the argument that people just don’t have the money,” Karlan explains.
Researchers Jonathan Zinman of Dartmouth College and Victor Stango of the University of California, Davis, have discovered another reason that we don’t
save: We forget about the power of compound interest—how, say, $10,000 invested at a 5% interest rate will almost triple in 20 years.
“Almost everyone severely underestimates how much interest they can earn on their savings,” Zinman says. The
same cognitive glitch applies to how we think about debt. Millions of Americans pay interest rates of 20% or
more on their credit-card balances, and these high rates will make even a modest amount quickly balloon. Never
under-estimate how much debt costs and how much your savings can grow.
Richard Thaler, a professor and behavioral economist at the University of Chicago, is convinced that there’s just
one way to save. “Having an amount automatically deducted from your paycheck is the only thing that
succeeds,” he says. “If we have to decide with every paycheck how much we should put aside, the answer is
often zero.”
However, all of this research on better ways to save does not shed light on why such large numbers of
Americans were steady savers in the past and why so many gave up on the practice. Economists Ulrike
Malmendier of the University of California, Berkeley, and Stefan Nagel of Stanford believe that our attitudes
toward risk are strongly shaped by the economic conditions we experienced when we were teenagers or young
Over the last two decades, stock prices rose strongly and downturns were relatively gentle. As a result, those
who grew up during this period became optimistic about future investments and willingly took big risks. Older
investors, shaken by the poorly performing stock market of the 1970s, acted with much more caution.
6 More Ways to Grow Your Nest Egg
Thanks to the present financial turmoil, today’s teenagers will probably have much less trouble saving when they hit adulthood. They’ll have seen firsthand that
saving is not about using your money to invest and make a killing on stocks or real estate; it’s about putting some of your money safely aside in an uncertain
world. That’s a lesson we should all start to learn.
Tim Harford, a “Financial Times” columnist, is the author of “The Logic of Life,” available in paperback.
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PARADE Magazine | How To Save Smarter
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Add Comment | Total: 2
Saving Tips
by pedersoc posted: 05/11/2009 02:50:PM
I have lots of savings tips on my website under Savings Swappers
REPLY | Number of replies:0
How to Save Smarter?
by Brian posted: 05/10/2009 10:52:AM
If you save based on emotion like the article implies, you'll never make it. It'll be like going on a fad diet, or getting high from a drug, or getting jailhouse religion. It'll be temporary fix that
(probably) won't last until the next one.
The study cited doesn't explain why people in similar economic conditions and/or similar upbring save differently. With my 4 siblings for example -- all of us baby boomers -- our savings
are all over the spectrum (with me being the most extremely -- maybe to a fault).
Bottom-line is, the best way to save is to have the money taken out up front, not even thinking about it -- then, use the rest that you take home to live the way you need/want.
As for today's teenagers and young adults, I'd bet that they won't learn their lesson any better than their parents did. (I can see that based on their current spending patterns. That's what
sets the pattern and basis for what they'll do as adults.)
REPLY | Number of replies:0
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