Why People Don't Save

Apr 15, 2007 by Adam C. Powell, Ph.D.

This blog and many others like it have extolled the virtues of saving. So, why don’t people save? Let us take a moment to explore the primary reasons.

Lack of Excess Capital

In order to put aside money in some form of savings, it is first necessary to have money to put aside. When people have expenditures that are perpetually larger than their income, saving money is impossible. In some industries, wages are increasing at below the rate of inflation. People tend to like the buy the same things one year after another; if I usually buy Dannon yogurt, I am unlikely to want to switch to buying generic yogurt in the event that my effective income decreases. Holding my consumption bundle (the stuff that I buy at the grocery store each time I shop there, etc) constant, if my annual wage increase does not offset price inflation, I will have less money for investing.

Higher Utility from Present Consumption

Right now, I’m not earning that much money as I am a graduate student. Some day, I’ll have a real job, and will be earning substantially more. Let’s say that I can get 10% returns on the money that I save today. I will earn a higher salary in about four years. If I spend $100 now, I won’t be able to invest it. However, if I invest $100 at 10% per year, I will have $146.41 in four years. However, if I earn 4x as much in four years as I do today, I might consider myself better off spending $100 today than spending $146.41 in four years. If I anticipate a large increase in income, the money might represent a far larger part of my budget today than it will represent in four years.

Financial Disincentives to Saving

There was an article recently in Slate by Henry Blodget about how U.S. tax policy discourages saving. Riskless investments (CDs, savings bonds, savings accounts, etc.) rarely produce a high enough return to counteract inflation. To make matters worse, interest earnings are taxed. Likewise, dividiend earnings from stocks are taxed. The taxation of earnings from investment and savings makes people have a stronger preference for consumption.

Myopia

Many people prefer to take life one day, one week, one month, or one year at a time. When it is unclear what life will bring, it may be difficult to devise a long-term financial strategy. For instance, if you have $100 but do not know if you will need to spend it in the next six months, you probably will be unwilling to purchase a six month CD. As a result, the money may be earning less interest in your savings account. Also, none of us know how long we will live; if we will see retirement, or be killed in a random catastrophe. By spending in the present, we ensure that we see some benefit from our labor.

Myopia can also make long-term investment strategies less appealing when people do have the ability to place some of their money aside for investing. While the stock market generally goes up, it occasionally goes down. As a result, people who view their stock market investments on a short time horizon may view them as quite risky, and wish to pursue a safer strategy. Although safe investments are nearly guaranteed to underperform investments in the market in the long-term, when viewed from a myopic perspective, they may be more appealing as they have less variance.