The concept of Behavioural Economics has been a significant contributor in non-fiction literature in recent years, not only because it is vastly more interesting than the more traditional economic doctrines. The relevance of the concepts to the individual readers has been advocated by economists and psychologists alike, wielding increasing influence in the world of academia.
One element of Behavioural Economics that has most impact on the clients we see is the practiced doctrine of regular savings. The biggest outcome from the research published is the changes to pension savings in developed markets such as the UK or Singapore. The respective governments have implemented automatic enrollment into pension schemes – this is also widely adopted in the US through the 401k schemes.
While globally automatic enrollment is growing traction, the difficulty then comes down to the rate of default contributions. From the perspective of behavioral economics, individuals often misinterpret the value of automated savings as a reduction in their disposable income, often leading many to opt-out of high rate contributions.
With low levels of income contribution to pensions being common, we can look further back to the impacts on other retirement savings and investments. In 1970, Robert N. Schoeplein published an article, “The Effects of Pension Plans on other Retirement Saving”1, evaluating the effects of enrolment into pension plans against other mechanisms for saving for retirement. The result of the study indicated that high income households allocated significant savings out of income to non-pensionable investments for their retirement.
In 1948 Homer Jones published two papers entitled “The Flow of Savings”2 which evaluated the direction in which investors tend to save. This paper explained in detail the effects of institutions, advertising and marketing campaigns to promote household savings. Emphasising capital formation from household savings, Jones noted that too much focus was put into cash deposits with banking and savings institutions, rather than equity investments.
When applying the practice of dollar-cost averaging to the investment savings (Jones, 19487), investors have the opportunity to reduce equity volatility prices. This process of drip-feeding capital into an asset over time, reduces the effects of fluctuating prices and can further mitigate the risks of entering the market at the wrong time (before a market correction) with a substantial single investment, exampled by the below graph:
Fig 13 – Showing the volatility reduction in rolling 10-year and 1-year index returns. Source: Financial Express. FTSE 250 Index. Data as of 09/03/2020.
Finally, a word for the selfless; save for your future self as soon as you get paid! Ensuring that, of the income you earn, you are the primary beneficiary is an important mental aspect of saving regularly. It is not a reduction in your disposable income; it is a contribution to your financial future!
The value of an investment will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested.
This article is a general communication being provided for informational purpose only. It should not be relied upon as financial advice and it does not constitute a recommendation, an offer or solicitation. No responsibility can be accepted for any loss arising from action taken or refrained from based on this publication. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted.
1 – Robert N. Schoeplein, The Effects of Pension Plans on other Retirement Saving; The Journal of Finance, 1970.
2 – Homer Jones, The Flow of Savings -I*; The Journal of Finance, 1948
3 – Fig 1. Source: FTSE International Limited (“FTSE”) © FTSE 2020. “FTSE ®” is a trademark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.