The truth about the psychology of saving and spending

Recently, I had a fascinating meeting with renowned psychologist and best-selling author, Dr Peter Collett, in which we discussed an important subject for anyone involved in financial services: the psychology of saving and spending.

Dr Collett is an expert on these issues, having taught and conducted research studies at Oxford University for many years, having authored several genre-defining books, and after appearing on various high-profile television programmes, including Big Brother, on which he is the resident psychologist.

Here’s the transcript of that meeting.  I hope you find it as insightful as I did.

Peter, to what extent are our financial and emotional behaviours linked?

PC. In fact there’s quite a lot of evidence to show that people’s financial behaviours are related to their individual psychology, and to historical and cultural factors as well.

What do you base this on?

PC.  I was worried that you might ask me that question, Mike! Well, back in the 1930s, Keynes predicted that as people became wealthier and had more money at their disposal they would increase their savings rather than their consumption.  Keynes proposed several reasons why people are motivated to save – for example, to protect themselves against unforeseen circumstances, to ensure that they can sustain and possibly improve their standard of living, and so on.  Well, it became evident that as people became increasingly wealthy they did not actually save more – and therefore that social and psychological factors needed to be introduced to explain why some people are conscientious about saving whereas others take a more cavalier attitude towards saving and investment.

So, what are the underlying psychological reasons why some people prioritise saving while others don’t?

PC. This, of course, is one of those 64 thousand dollar questions, to which I don’t believe there’s a single, definitive answer.  There are, however, some interesting clues to why some people are more focussed on saving than others.  One is cultural – in countries like Vietnam, India and China, saving is the natural order of the day.  In these countries it’s simply accepted that investing and putting money away for a rainy day is what sensible people are supposed to do – an attitude which, unfortunately, isn’t shared by the citizens of the U.K., the United States and Greece, where the emphasis is more on immediate consumption and living on credit.

Why do countries differ so widely in terms of their saving rates?

PC.  Well, partly it’s historical. Take the celebrated case of Japan, which was held up as a model of savings back in the 80s.  Since then, however, saving in Japan has reduced dramatically – so much so, in fact, that the country now finds itself near the bottom of the saving league table, rubbing shoulders with imprudent countries like the United States and the U.K.  The behavioural economist, Keith Chen, has offered an intriguing explanation for cross-national differences in saving rates.  According to Chen, it’s all down to the underlying structure of the language.  People who speak a “futured language”, which draws a strong distinction between the future and the present, find it more difficult to save because their language is constantly reminding them that they’re postponing gratification to a very different period in time.  On the other hand, people who speak a “futureless language” – one that doesn’t distinguish the future from the present – should find it much easier to make savings because delayed gratification doesn’t seem to involve any noticeable delay.  This is certainly a very compelling theory, and it’s apparently supported by data on saving that’s been aggregated over several decades.  The only problem, however, is that the theory can’t explain why a country’s propensity to save is able to change over time. Japan, for example, with its “futureless language”, once headed the international rankings for savings, but over the last few decades it has slipped all the way down to the bottom – and it’s done so without changing its language!

But surely, isn’t saving linked to the ability to save?

PC.  When you sit people down and ask them why they don’t save, one of the standard explanations they offer is that they can’t afford to do so.  That’s because they’re thinking of savings as what’s left over after they’ve paid for essentials, rather than of essentials as what’s left over after they’ve ear-marked money for saving – it’s their savings that get squeezed, not their consumption.  The widely held idea that people don’t save because they can’t afford it has been completely discredited by the extensive research conducted by Daryl Collins and his colleagues.  These researchers set out to investigate how the world’s poor manage to get by on $2 a day and they discovered that, in spite of their grinding poverty, most of the poor people they interviewed round the world managed to find ways to save for the future. It is worth remembered this next time you’re sitting in a smart hotel, chatting to some guy in a Savile Row suit, and he starts to complain that he can’t afford to put any money aside for saving!

What about the psychology of not saving?

PC.  There are several explanations that people give for not saving, and most of them, I suspect, are excuses rather than reasons.  When someone tells you that they don’t save because they don’t earn enough, or because prices continue to rise, they’re likely to be offering a rationalisation rather than an explanation for their inertia.  The real reasons why people don’t save are seldom economic – they’re much more likely to be psychological. One of the reasons why people don’t save is that they cling to the illusory idea that things will somehow improve – that, regardless of their efforts, things will get better, they’ll get lucky, their talents will suddenly be recognised, and all their financial worries will disappear. This type of wishful thinking relies on what psychologists call “false optimism” – a distorted image of the future that bears no relation to the available evidence.  It works because people can convince themselves that there’s no need to endure the hassles of trying to save money when things are bound to work out in their favour anyway. Some people who refuse to save are afflicted with a “Peter Pan syndrome”, where they refuse to take responsibility for their future, assuming – just like a child – that it will all get sorted out by adults.

Isn’t the act of saving a way of making a statement about the future?

PC.  Yes, you’re absolutely right!  It’s about what behavioural economists call “intertemporal choice” – in other words, deciding whether to consume now or whether to save and postpone consumption until some point in the future.  As a rule, people are prepared to delay consumption if there’s sufficient compensation for doing so.  Given the choice, they’re more likely to opt for a situation where they receive £120 in a year’s time, for example, than one where they get £100 today, but they’re reluctant to swap £100 today for the promise of £102 in a year’s time. People differ according to what they consider to be acceptable compensation, and this in turn may be affected by their perceptions of the relative costs and benefits of immediate consumption versus saving for the future. Those individuals who’re less concerned with the future are much less likely to save, and the same is true of people who have trouble identifying with their “future self”. It’s been found that people who fail to see their “future self” as an extension of their “present self” are far less likely to put money aside for the future. After all, why would you want to share your hard-earned savings with someone who doesn’t feel like they’re actually you?   Personality factors like impulsivity and self-discipline also play a part in deciding whether someone saves for the future.

Can a non-saver ever truly become someone who prioritises saving?

PC. Yes, I believe that people can change, especially if they’re helped to do so. Take the case of “the disturb”, a technique that financial consultants use to persuade their clients to change their ways – and one on which I know you’re an expert.  Well, the reason why “the disturb” is so effective is that it confronts the client with a future scenario that he or she has either denied or studiously ignored. It invites the client to envisage the dire consequences of doing nothing – a process which, let’s face it, can be extremely painful.  Here the cards are definitely stacked in favour of change.  No longer able to deny or rationalise his situation, the client is forced to choose between the inconvenience of saving and the certainty of future regret. Given this choice, most clients should opt for saving, which – paradoxically – becomes the least painful option on the table.  It follows from this that those clients who have neglected their finances, or who have a particularly vivid imagination, or who are prone to regret, are the ones who’re most likely to succumb to “the disturb”.

When someone who has traditionally neglected his finances decides to commit to a saving regime, it doesn’t mean that his core personality will change overnight.  It does mean, however, that certain aspects of his personality, like his ability to cope with disappointment and regret, will come to the fore and encourage him to save.

So, should wealth managers be using personality profiling with their clients? Would this be helpful in general terms?

PC. Wealth managers should definitely be using some kind of psychological profiling in their dealings with clients, even if it’s rudimentary.  If follows that the more you know about your clients – what motivates and turns them on, which buttons to press – the more effective and successful you’re going to be.

Comments

  1. There are so may articles written about overspending but there is very limited literature on the reverse cases. I as a financial planner and CPA come across individuals who cannot spend at a higher level matching their level of wealth . For instance a successful retired attorney with Nore than 10 m at age 92 lived like a poor person. He did not have any own family that may be in need in future. Even though this is a non ordinary case, in my small client list and friends I have noted more than 10 instances of similar nature. Is there a rational explanation for this human behavior?

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