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Why Do People Find It So Hard to Save?

By Mark Harrison, CFA
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 brains
biochemical reactions under stress can lead to highly dysfunctional beh avior. 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 s avings
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 investors 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 investors
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 portf olio

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 Digests 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 amo unt 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 riskreturn 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 currencydenominated securities.

The Taxation Paradox: Its 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 ac ross 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 brains 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