Why Some People Invest and Others Don't

Our unique psychological profiles spearhead the decisions we make, including decisions about our finances and investments

27/10/2021 09:52:00
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On the surface, increasing one's savings can seem as easy as merely clicking a button on a bank's app. Emergency savings are an important lifeline for households to persevere through a financial shock. Even so, saving money is an area where many people struggle.

Researchers often look at sociodemographic variables, such as age or income, to make predictions about people's saving habits. But the decision to save, of course, extends beyond one's basic demographics--our unique psychological profiles spearhead the decisions we make, including decisions about our finances. What does behavioral science teach us about our problem with saving and how we can overcome it?

That's what a group of psychologists decided to explore a few years ago, when they studied which psychological variables contribute most to household savings in a sample of UK households. Researchers Patrick Gerhard, Joe Gladstone, and Arvid Hoffmann compared some of the most widely used psychological predictors of savings (self-control, financial goals, and financial literacy, for example). This specific study examined savings in the context of an immediately available "rainy day fund", rather than longer-term savings that are harder to liquidate, like retirement savings.

One key aspect of this study is that the authors classified participants as either "striving" or "established" based on a statistical analysis of demographic information. Established households tended to be older (generally over the age of 45, with people age 65 and older being most likely to belong to this group) and of higher income. Conversely, striving households were younger and of lower income. The authors then regressed a household's total emergency savings on the set of psychological predictors, separately for both types of groups of households, and found that these traits don't affect everyone's savings habits in the same way.

Some Important Insights

1) Younger households may be more unable rather than unwilling to save. 

We may have heard time and time again about the benefits of self-control in savings. Indeed, it takes willpower to save some money one could otherwise spend. Interestingly, self-control did not play a role in saving habits among the striving households. This finding suggests that younger households aren't averse to savings; they simply aren't able to save yet. When resources are present, however, the benefits of self-control have a stronger impact: A one-unit increase in self-control was associated with a 16% increase in savings among the established households.

2) Goals focused on financial gains are helpful, especially for the "striving".

A goal can be considered "promotional" if it aims to achieve gains, such as buying a new house. Both established and striving households benefit from holding promotional savings goals, although the benefit was especially strong for striving households. Specifically, the addition of even just one promotional goal was associated with almost a 99% increase in emergency savings. This figure was approximately 20% for established households.

3) Prevention goals can also help - if you're younger. 

Prevention goals aim to avoid losses, such as maintaining emergency savings for unexpected expenses. This study revealed that the addition of even a single prevention-focused savings goal (which includes the goal of building a rainy day fund) was associated with a 127% increase in savings among striving households. Conversely, this goal orientation hurt the savings of established households; it was associated with a 15% decrease in savings for these households.

4) Optimism can be counterproductive for saving habits. 

Optimism has many psychological benefits. But it can also deplete our savings, especially when we're younger. Each unit increase in the study’s self-reported measure of optimism was associated with a savings decrease of 57% for striving households and of 16% for established households. Optimistic people may not expect the worst to happen in the future, thus are less likely to save for such an uncertain occasion. This is not to say that being pessimistic is advantageous (neuroticism was unrelated to savings). Rather, it is important to find the right balance between being optimistic and being realistic about the unforeseeable future.

Lessons Learned 

This research has revealed some interesting insights into the psychology of household savings. Here are some lessons we can draw from these findings.

1) Identify where you are in your life's timeline.

Are you "striving" or "established?" This may be an important question for both individual investors and advisors to consider when drafting a financial plan. As this study showed, strategies that could help one group may not help the other. Self-control is a prime example of this discrepancy, as it benefited older households but did not play a role in younger households' saving habits.

2) Prevent losses accordingly.

The younger striving households are still facing many of life's uncertainties. As this study showed, setting prevention goals may be especially beneficial for these households in helping them develop strong saving habits. Indeed, these households may rely on debt to pay for larger expenses such as a car, so setting prevention goals can help stay the course in paying the debt on time while still saving some money.

3) Promote promotional goals.

Unlike prevention goals, promotional goals were beneficial for both types of households. Indeed, many promotion goals entail some kind of ideal outcome for the saver, such as that dream house or perhaps a promising stock. Because it's easier for us to visualise the tangible outcome of the goal, there's an extra push to put a few dollars away.

4) Be realistic.

Optimism is a healthy trait, but in some cases it can serve as a blindfold. In a perfect world, we would see no volatility and experience consistent gains from our investments. But since such a utopia exists only in works of fiction, it's important for investors to balance a sense of optimism with the reality of random volatility that the future can bring. 

 

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