How Scarcity Challenges Our Ability To Save
Across Asia, from the UAE to South-East Asia, we are not saving enough to meet the goals we set for ourselves. Millions of us sit down at some point during the year, perhaps after a major holiday, and look at our financial situations and decide that changes need to be made. Often with our spouse, we look carefully at where money is being spent, plan out ways to save more, pay down credit card debt, many even write down their plans with the help of a professional. And yet, 53% of UAE residents (1), 64% of Indians (2), and 50% of Thai (3), believe they are not saving enough to meet their long-term goals. What’s going wrong, and what can we do about it?
Let’s think about this problem by looking at it through the experiences of the saver, we’ll call him Mr. Saver. It’s the end of the month, the month just after a big national holiday, and they have spent more than intended, and are now looking at their credit cards, and savings accounts, they’re anxious, and a little frustrated.
Mr. and Mrs. Saver are determined to address this, and put their family on the right path. Mr and Mrs. Saver sit down the next morning and after their coffee, they put all their bills on the table, and begin to look at home much they spend on groceries, fuel, entertainment, and travel. They decide that they can tighten their belts and eat more at home, take more modest vacations, and maybe downgrade their TV package. If they do this, they’ll be able to pay off their credit cards and also save for their futures. They even put all this down into a Google Doc and save it as their plan. All seemed great, it worked for nearly a month. Then, Mr. Saver and Mrs. Saver were out picking up some clothes for their child, Mrs. Saver was too tired to cook, but had just gotten paid and so they decided, just this time, they’d go eat at the restaurant at the mall they’re in (they’d been good after all). They ate healthy, but they ordered dessert, as a reward for “being good.” And, just like that, their detailed savings plan, the one they spent the whole morning putting together, was busted.
Why did they fail?
Financial Planning, The Breakfast Session: Optimism Bias and The Planning Fallacy
People are generally optimistic, particularly when a decision has consequences that are far off into the future. In this case, Mr. and Mrs. Saver set a goal to pay off their credit cards one year from now making the consequences of their dinner less relevant to them at the moment. Second, because they were optimistic, they only planned to have dinner out every three months, and believed firmly that they had the willpower to make this so. Mrs Saver had decided she would make larger meals and freeze them, so even when she was tired, there would be food available for dinner (this is what busy Mom’s, just like her did). She did know her other busy Mom friends tried this, and still told her stories about eating out, usually because they were tired of eating the same old things. But, she was different, they would stick to their eating out once every three months plan. Objectively, we can see Mr and Mrs Saver were setting themselves up for failure, right from the beginning.
Their second mistake while sitting at the kitchen table was a mistake caused by what behavioural scientists call the planning fallacy. This is a problem that afflicts us when we try to predict how long something will take. Remember their goal of paying off the credit cards in one-year? That happened because they predicted an optimal amount of additional savings they could find, and minimized the likelihood that they would have unplanned expenses. The planning fallacy is also a chief cause of major construction projects taking longer and costing more than predicted. The real eye-opener with the planning fallacy, is the smarter the individual, the more they are afflicted by it.(4)
Navigating The Day To Day: Tunnelling, Control, and Willpower
To understand why Mr. and Mrs. Saver were unable to resist the dinner out after grocery shopping, we need to differentiate that a cold state, the breakfast planning session and hot states, where we’re conducting habitual tasks like grocery shopping after a long day of work use different mental processes. In particular, Mr and Mrs Saver were affected by an effect known as tunnelling. Tunnelling occurs when we are needed resources are scare, with time, money, and food being common scarcity scenarios. In such situations, our cognitive resources sharpen or narrow on the most urgent or pressing problem. In a positive sense, this ability allows us to find novel solutions to our biggest problems, but an important negative, less urgent problems get pushed out of that focus. This is what happened to Mr and Mrs Saver.
Now finished their grocery shopping, their 6 year old son was hungry and tired, Mr Saver had a long day in the office trying to submit a proposal against a tight deadline, and Mrs Saver skipped lunch because her meetings ran long. She thought for a moment about the leftovers she had made and and realized she had forgotten to take them out of the freezer. In this cloud of momentary anxiety, she the eating out decision was made, the carefully planned eating out only every three months plan, out of focus, and forgotten. Her willpower was not enough to resist the temptation that she and Mr Saver had planned so hard to avoid.
Exercising willpower requires what psychologists refer to as executive control, a set of cognitive skills that are responsible for planning, initiating, sequencing, and monitoring progress towards goals, our rational skills in other words our rational skills(5). As we begin to tunnel like Mrs Saver did, our IQ drops by as much as 14 points in what Sendhil Mullainathan has coined the bandwidth tax(6), and that tax made it considerably more difficulty to resist temptation(7). This is why Mr and Mrs Saver succumbed to the unplanned dinner outside, the tunnelling effect presented a solution to resource scarcity (time and calories), her choice was habitual (eating out was partially responsible for their poor savings) and therefore easy, and she because she was tired, and anxious to a degree, the easy choice crowded out the long-term goal which wasn’t as important. So what can we do, and can our bank help us with this kind of problem?
What Can We Do?
(1) Mr and Mrs Saver failed to provide enough slack in their financial plan for things like eating out. For their plan to have worked, Mrs Saver would have to never forget to take food out from the freezer (unlikely). Working with an outsider, like a financial planner would have helped them counter the optimism bias that led them to plan for Mrs Saver never forgetting to do that. An outsider would have helped them put a little slack in their budget, by allowing for occasional slip-ups like this.
(2) Cognitive Behavioural Therapists have suggested that”If-Then” plans could help. Essentially, a pre-commitment is made by Mr and Mrs Saver that “If” they become tempted, “Then” they will eat the instant noodles they keep at home for precisely such situations. “If-Then” plans are best written down and would be used during that same breakfast planning session.
What Can Our Financial Institutions Do?
(3) Long-term goals don’t often provide sufficient feedback to keep us motivated, so breaking progress into smaller “chunks” could help. A small intervention deployed by banks in Peru, Bolivia, and in the Philippines increased savings rates by 6%(8). The intervention was simply to notify savers of the balances in their account. This serves to show progress against that goal.
(4) We are more likely to succumb to temptation during moments when we feel less resource constrained. Mr and Mrs Saver will feel less constrained on the day they get paid. A bank could leverage this by asking us at this moment if we wanted to save extra money to meet our long-term goals. For farmers in Kenya, fertilizers can have a significant impact on crop yields, and financial rewards, but many don’t take advantage, despite knowing of its benefits. However, when the option to purchase that fertilizer was made at the moment of sale, fertilizer usage increased from 29 to 45%(8), addressing a long-term goal.
(5) Automated savings products that round up transactions and move the difference into a special savings vehicle would help Mr and Mrs Saver reach a long-term goal, without expending any cognitive effort. These solutions have been applied to primary bank account transactions, loan payments, and even credit card transactions.
Long-term goals are hard for most of us to meet, by applying behavioural science, we as financial services professionals can design better solutions that help our clients achieve their financial goals, making us more valuable partners.
- (1) https://www.businesstoday.me/breaking-news/53-percent-of-uae-population-not-saving-enough/
- (2) https://cdn.pficdn.com/cms/pgim4/sites/default/files/2020-11/PGIM-India-retirement-readiness-survey-2020.pdf
- (3) https://www.newswire.ca/news-releases/70-of-canadians-think-they-won-t-save-enough-for-retirement-scotiabank-poll-896861522.html
- (4) Heuristics and Biases: Inside The Planning Fallacy, 2013: The Causes and Consequences of Optimistic Time Predictions, Buehler, Griffin, and Ross
- (5) https://neuro.psychiatryonline.org/doi/pdf/10.1176/jnp.14.4.377
- (6) Scarcity, Mullainathan and Shaffir, 2013, P216
- (7) The Truth about Trust, DeSteno, P108, 2014
- (8) Scarcity, Mullainathan and Shaffir, 2013, P207