Why we don’t save enough



heatherAmong the biggest concerns of most investors is the adequacy of savings earmarked to sustain a financially successful retirement.  Amplifying this worry are increases in the cost of living and increased longevity.

“’Enough’ and ‘sufficiency’ are words that require particular definitions in the context of retirement,” says Heather McCulloch, Head of Retail Investments, Western Cape for Foord Asset Management.  “For retirement planning purposes, one might hear reference to the ‘replacement ratio’, which is the proportion of one’s income immediately before retirement that is required to be sustained after retirement. Globally, it is generally accepted that replacement ratios of between 70% and 100% are sufficient, however, in South Africa where retirees cannot depend on state aid, research has been biased towards the need for even higher replacement ratios.”

According to McCulloch, when viewed through this prism, too many people lament having saved insufficiently for retirement. This outcome is regrettable but is rooted in our human behavioural characteristics.

The first of these characteristics is myopia: We have a bias towards the present and place greater value on lifestyle experiences now than rewards in the future.  In addition to this, a consumer mind set abounds – to highlight this, a recent study in the USA showed that 75% of surveyed households could not park their cars in their garages for want of the space taken up by “stuff” that had been accumulated over the years.

The second behavioural trait, according to McCulloch, that militates against successful saving is loss aversion. Loss aversion is often explained as the pain of losing wealth (even if transient) or the reluctance to experience such loss. But it also manifests in the simple reluctance of people to make do with less.

“The third element influencing a poor savings rate is lack of knowledge,” says McCulloch.  Here, lay people are not entirely engineers of their own misfortune: The financial services industry thrives on excessive choice and confusing jargon. That said, investors should ask simple questions to which they deserve uncomplicated answers.

“The nub of any retirement savings plan is formed on these questions: How long do I have to save? How much do I want and need to have as a retirement income? How long do I expect to live in retirement? What returns can and should I earn on my investments before retirement and after retirement?”

So how can we save ourselves from ourselves and ensure that our savings for retirement are at least adequate?

McCulloch says that perhaps the first steps are to use our own behavioural biases to our advantage.  “Firstly, consider making saving for retirement a default option rather than an active choice. It is in our natures to procrastinate on decisions that require active intervention. In contrast, we tend to have little regard for actions that occur without our decisions. In investing parlance, the most obvious of these types of actions is the automatic, regular contribution to retirement savings, for example, retirement fund contributions or investment into unit trusts by monthly debit order.”

“Secondly, we can prevent our natural inclination towards the tendency to prefer smaller rewards sooner than larger rewards later. This can be done while being mindful of our equally natural aversion to loss. Behavioural finance researchers Shlomo Benartzi and Richard Thaler have coined the phrase ‘Save More Tomorrow’. Using this mind set, investors are encouraged to invest more of their next increase or bonus tomorrow, rather than cutting spending today. If the necessary commitment can be achieved, then the rewards will follow,” concludes McCulloch.