Practical analysis for investment professionals
12 August 2013

Why Do People Find It So Hard to Save?

The allure of hedonistic lifestyles, of “wine, women and song” (“sur, sura, sundari” in Hindi), translates into almost every language. The Spanish say, “naipes, mujeres y vino, mal camino” or “cards, women, wine and bad ways,” whilst Persian speakers say, “kabab, sharab va shabab” or “meat, wine, and youth.”

So, with the apparently universal human impulse to “gather ye rosebuds while ye may,” why do people forgo the immediate pleasure of consumption and bother with all the self-denial involved in saving? The easy answer is they are fulfilling a basic need to meet their future liabilities, which might be known or unknown. People save to provide for unknown emergencies such as the costs of fixing a leaky water pipe. But much saving is fairly predictable, for example pension needs and those big ticket items — a car, wedding, or house. Finally people save to generate future income streams. Put like this, saving sounds like a fairly simple business. So what are the impediments to successful saving?

There are some fairly obvious impediments, such as falling victim to a scam. Neither wealthy organizations nor intelligent individuals are immune to the devastating effects of financial predators, according to one recent study. Financial predators build blind trust by instilling a high level of satisfaction, and satisfaction and predatory behavior are mathematically related — in other words, pretty predicable.

Then there are the all too obvious flaws of the human brain, especially when we gather in groups. The brain is hooked on being right, according to one writer, and the brain’s biochemical reactions under stress can lead to highly dysfunctional behavior. Several common behavioral patterns have no representation in existing economic models. For example, contrary to what most economic models assume, people often change their preferences over time and under different circumstances.

Some would argue the mechanism by which savings are collected from people and pooled is almost as political and dysfunctional as the mechanisms by which these pooled savings are ultimately invested in the financial markets and the real economy. Politicians create tax policies and tax incentives to save (often designed to reduce the burden of the welfare state on taxpayers). But tax incentives and taxation generally can be distortive to capitalism. At the portfolio level, taxation has a marked influence on investment performance, terminal wealth, and consumption, according to one recent study. Managing assets in a taxable setting has economic implications, and merits consideration in a global context.

Perhaps the best advice is to save over a long period and take advantage of diversification across time. But how much exposure should investors place in risky assets? One recent study from researchers at Yale suggests a new method of measuring and calculating an optimal allocation to equities in an investor’s portfolio using the present value of lifetime savings instead of just using the value of current savings. Other recent studies examined the role of comfort assets, such as socially conscious stocks or gold bars, in an investor’s portfolio. Liquidity is another asset which many investors struggle to account for when forming portfolios. By accounting for liquidity as a shadow allocation to a portfolio investors are better able to incorporate liquidity into their portfolio decisions.

Standard mechanisms through which pooled savings are administered and invested are far from exempt to criticism. John C. Bogle, founder of Vanguard, spoke recently at a CFA Institute conference to condemn the recent proliferation of investment products in the investment industry and champion low-cost diversified portfolios offering dividend yield and earnings growth. Ultimately, though, if self-regulation of any industry fails to deliver for its customers it invites the heavy hand of stern regulation.

Further reading from CFA Digest’s team of abstractors and other CFA Institute resources on investing and related topics can be found below:

  • How Well Do Stock Prices Reflect Intrinsic Values? A legendary fund manager champions the importance of low-cost, diversified portfolios, with dividend yields and earnings growth as the key sources of long-term investment returns. The ownership of mutual fund management companies by financial conglomerates creates an agency conflict that does not serve the interests of shareholders. The growing proliferation of investment “products” is one example of the incentives that drive fund managers to increase assets under management, revenues, and profits as well as to keep management fees and fund expenses at the highest possible levels.
  • Satisfaction and Financial Predation: A Large Group Study Revealing Their Mathematical Link: Neither wealthy organizations nor intelligent individuals are immune to the devastating effects of financial predators. Financial predators build blind trust by instilling a high level of satisfaction. Satisfaction and predatory behavior are mathematically related, which provides a tool for understanding how financial predators seize their clients’ or employers’ wealth.
  • Diversification Across Time: An allocation to equities of a fixed percentage of the present value of projected lifetime savings, instead of a fixed percentage of current savings, allows investors to accumulate the same ultimate amount of wealth with less risk. The implementation of this time-diversifying method requires the use of leverage when the present value of future savings allocated to equities is greater than current savings.
  • Liquidity and Portfolio Choice: A Unified Approach: Many investors struggle with how to account for liquidity when forming portfolios. By accounting for liquidity as a shadow allocation to a portfolio, attaching either a shadow asset to tradable assets or a shadow liability to nontradable assets, investors are better able to incorporate liquidity into their portfolio decisions.
  • Recognizing Investor “Comfort” Assets in Portfolio Optimization: Not all asset decisions fit neatly into the traditional risk–return paradigm of portfolio selection. For example, investors may wish to include in their portfolios a minimum percentage representation, or an absolute dollar amount, of socially conscious firms. The author presents an alternative to the traditional technique and illustrates it using gold as a comfort asset as applied to a portfolio of foreign currency–denominated securities.
  • The Taxation Paradox: It’s Global, Not Local: Global tax codes can be idiosyncratic and complex, but general taxation structures can be grouped into broad categories and assembled into global taxation models that can be applied across jurisdictions, thus improving the service and after-tax results wealth managers provide to clients.
  • The Debt to Pleasure: Existing economic models often fail to explain real-life behavior. The author offers several examples of behavioral patterns that are not explained by current models. Contemporary economists should pay closer attention to developments in such sciences as psychology, neuroscience, and anthropology if they want their models to achieve a closer relationship with real-life economic decisions.
  • Your Brain Is Hooked on Being Right: The brain’s biochemical reactions under stress can lead to dysfunctional behavior in groups. To produce a countervailing hormone conducive to cooperation, the author offers some straightforward collaborative exercises that apply effective communications strategies.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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About the Author(s)
Mark Harrison, CFA

Mark Harrison, CFA, was director of journal publications at CFA Institute, where he supported a suite of member publications, including the Financial Analysts Journal, In Practice summaries, and CFA Digest. He has more than 12 years of investment experience as a portfolio manager and securities analyst. Harrison is a graduate of the University of Oxford.

3 thoughts on “Why Do People Find It So Hard to Save?”

  1. Rajeev Thakur says:

    Its a good article but I dont agree with bullet point 3 as a method for allocating savings to risky assets.

  2. Jameson says:

    Human nature indeed. From a more general view, I’d wager that we humans are so myopic and short-term about our thinking that it is so very few who realize the beauty of delayed gratification, i.e, saving aggressively before spending on non-essential wants. Yet, very, very few have the personal fortitude to admit as much, and many many more do not even realize it. A good segue’ into our responsibility as financial advisors to advise people wisely and even educate those who are misinformed or uninformed about these things. but educating others about their hard earned money in a non-adversarial way is paramount- and it’s hard to do too. Even being a so-called finance professional i constantly battle with my inner dialogue to remind myself to save first, spend later.

  3. John Taabavi says:


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