Roxanne Bauer

Saving for Change: Why is it so difficult for people of all income levels to save money – and how can financial institutions help?

Saving money is hard. However, it is also necessary for making large purchases like a house or car, opening up a business, or planning for retirement. Saving can be particularly difficult for the poor who live day-by-day and do not have much disposable income. In wealthier countries, financial institutions offer a variety of products to help their clients set aside savings, but in poorer countries, there are fewer savings options. Many poor people end up hiding cash, investing in assets such as livestock or land, or engaging in informal savings arrangements.

Yet, for those who have even a little money to stow away, the benefits can be enormous. Massachusetts Institute of Technology (MIT) economists Abhijit Banerjee and Esther Duflo have found that even those who live on less than $1 per day have the ability save and often spend money on nonessential items such as alcohol, tobacco, and televisions. Moreover, when poor people increase their earnings, they spend only two-thirds of their increased income on food. These findings suggest that poor people do have funds to save.

But why is it so difficult for people of all income levels to save?

One reason is loss aversion. Researchers have determined that people require much more to give up something they already possess than they are willing to pay for it. In an experiment by psychologist Daniel Kahneman and economists Jack Knetsch and Richard Thaler, a group of Cornell University students was asked how much they would pay for a mug with the university’s logo. The group was then divided in two, and only one half was given a mug. The students were then allowed to buy or sell the mugs in a “marketplace.” Contrary to what one might expect, the students with mugs were highly unlikely to sell them—even if they did not value them highly and were not willing to pay much for one when asked. The students with mugs viewed selling them as a loss, and the students without mugs viewed buying one as a gain. In banking, setting aside money into a savings account may feel like a loss because it prevents a gain in the current context.

In order to rise above loss aversion, banking and finance institutions should make the gains of a savings accounts concrete. Labeling accounts for “emergencies,” “house,” or “retirement” may help remind people why they are saving. Secondly, providing visual reminders why a savings account was set up may also remind people of future gains and distract them from the loss they are currently experiencing.

Another reason saving may be difficult is that it requires the formation of a new habit and the displacement of old habits. In The Power of Habit, author Charles Duhigg, states that old habits are hard to break and new habits can be difficult to form because the behavioral patterns we repeat as habits are literally written in our neural pathways. When behavior becomes habitual, it is guided by automated cognitive processes, and is not associated with elaborate decision processes. However, through repetition, it’s possible to form new habits and maintain them as well.

To overcome bad habits, it may be easiest to make savings deductions automatic, mimicking the automatic process of a habit. This was successful in a series of experiments directed by economists Esther Duflo, Michael Kremer and Jonathan Robinson in which they offered different savings plans to farmers from Busia, Kenya with cash from a recent harvest. Some farmers were given the choice to immediately set aside money in a savings account dedicated to fertilizer (an investment the farmers cannot afford by the time planting season comes around), some farmers had to wait a few days to deposit savings, and others were not told about the fertilizer account but were able to buy the fertilizer later, during the planting season. They found that 57 percent of the farmers who immediately paid into the savings account bought fertilizer, 30 percent who had to wait a few days to pay bought fertilizer, and only 17 percent of those who were not told about the account were able to purchase fertilizer come planting season. This confirms the research on the success corporations have had in automatically enrolling employees in retirement savings plans.

Saving money can mean very painful and difficult cutbacks in the short run, but the fact that many poor people are willing to save also means that there is recognition of its benefits. Innovative savings accounts that offer labeling and visualization, reminders, and automatic deductions may help.

Editor’s note: This post was originally published on the World Bank’s blog. It is cross-posted with permission.

Roxanne Bauer is a consultant to the World Bank’s External and Corporate Relations, Operational Communications department.

financial inclusion, poverty alleviation, savings