Team Joker—Save More Tomorrow

David Banaszak, Brian Levitsky, and Liang Ye

Introduction
In this paper, we first examine the theory of rational saving and then compare it to the
experiences of our classmates. Next we argue that the theory cannot adequately predict some
behavior and then discuss methods proposed by Sunstein and Thaler such as the Save More
Tomorrow program to address this discrepancy. Ultimately, we argue that the Save More
Tomorrow policy is effective given our information.

Rational Saving

The theory of saving based on rational behavior was established by economists decades
ago. This theory was developed by Modigliani (Deaton, 2005). The theory states that young
people will save so that when they are old and either cannot or do not wish to work, they will
have money to spend. The very young have little wealth, middle aged people have more, and
peak wealth is reached just before people retire. As they live through their golden years, retirees
sell off their assets to provide for food, housing, recreation, children and other expenses. The
assets shed by the old are taken up by the young who are still in the accumulation part of the
cycle. Exceptions can be made for those who spend at an early age on major investments like
education, which sends many young people into debt, as long as the basic principle described
above is followed.

According to Modigliani, if the economy is growing or if there are more young people
than old, then more people will be saving than dissaving, so that the total dissaving of the old
will be less than the total saving of the young, and there will be net positive saving. In other
words, if aggregate income is growing, ceteris paribus, the young will be saving on a larger scale
than the old are dissaving so that economic growth, like population growth, causes positive
saving, and the faster the growth, the higher the saving rate.

The Life Cycle Investment Guide

Burton G. Malkiel, in A Random Walk Down Wall Street, proposes a “Life cycle”
investment guide in order to help people efficiently allocate their assets at certain stages in their
life. The last two stages that Malkiel covers are particularly important in that individuals should
be in transition towards retirement. He explains that individuals whose age is around the mid-
twenties should allocate their investments into more risky options. Their lifestyle at such an age
is an abundance of time to ride out investment cycles and a solid stream of income not quite
enjoyed at an earlier point in life. The recommended efficient allocation of assets someone of
mid-twenties is 5% cash, 20% bonds, 65% stocks, and 10% real estate (Malkiel, 346).
 As investors age, the opportunity to continue risky investment options diminishes as a
demand for family expenses increases such as needing to allocate money towards college tuition
for children. Yet, the opportunity to continue in more risky investments is still available to
couples without any children. The recommended efficient allocation of assets from someone of
late thirties to early forties is 5% cash, 25% bonds, 60% stocks, and 10% real estate (Malkiel,
346). As an individual reaches the age range of mid-fifties they should become retirement
focused in their asset allocation no matter the lifestyle factors. An emphasis upon income
protection during retirement over income production should correspond to more conservative
investments. The recommended efficient allocation of assets from someone of mid-Fifties is 5%
cash, 37.5% bonds, 50% stocks, and 12.5% real estate (Malkiel, 347). Finally, an individual in
their late Sixties and beyond have the lifestyle factors of being able to enjoy leisure activities,
protecting against healthcare costs, and be very risk averse. There should be a complete
emphasis upon income protection and investments should be made into bonds. The
recommended efficient allocation of assets for someone of late Sixties and beyond is 10% cash,
40% bonds, 35% stocks, and 15% real estate (Malkiel, 347).

This guide provides a great framework for how to plan out investments in assets or
saving allocations outside of just a 401k plan. It does however seem to require consulting a
broker or expert for advice upon how to effectively invest within bonds, stocks, and real estate.
That produces an issue of whether people are actually willing to seek advice and to do so in a
timely fashion.

A Culture of Spending

This paper will now turn to the discussion we had in class about savings and compare this
discussion to the theory. One theme which came up repeatedly in our conversation is what we
here call the “culture of spending.” This refers to the inescapable presence of consumerism in the
United States and is relevant to the topic of savings because money which is spent on non-
durable consumer goods cannot be saved. We assume that without these pressures to spend,
people would otherwise save; therefore, we want to understand the culture of spending and
compare it to standard economic theory to determine whether or not the theory predicts this
behavior.

The culture of spending may be attributable to advertising. One student commented in

class that he was under “a constant barrage” of Internet advertisements. Indeed, several of these
advertisements can appear on the same web page. The effect of this advertising is demonstrable
in another comment from a student who said that her mom will buy socks when they are on sale
even when she doesn’t need them. Aside from advertising there appear to be sociological causes
for consumerism. More than one century ago, Thorstein Veblen argued that people wish to
display their wealth (what he called “conspicuous consumption”). Today we see that when
people display their wealth, others want to follow: this is colloquially termed “keeping up with
the Joneses.” People inclined to feel pressure from the spending of others will therefore spend
more than what they need to in order to feel as though they are in the “haves” group and out of
the “have-nots.” One student said that she feels as though she needs to have the right brand-name
boots and purse, indicating the power of this pressure.

From these comments which were raised in class, it would appear that consumerism is an
irrational behavior, though others pointed out that it can in some cases be rational. One student
noted that rising levels of inflation can make savings worth less in real dollars over time so there
is an incentive to spend in the current time period, although this pressure is low given that the
March 2010-2011 change in CPI was only 2.7% (Bureau of Labor Statistics, 2011). Some of
these reasons are old (social pressures) while
some are new (internet ads) but the effect is
that people are spending when they do not
need to, and this means that they are
proportionately saving less over time.
According to the theory of rational savings,
people should spend whatever money is left
over after taking savings into consideration
but our examples demonstrate that the
decision to spend is made independently of
these considerations. Granted, our information
is taken from college-aged students who may
not be generating income, though we argue
that this behavior is seen among Americans
generally, including those who are generating income.

According to the Bureau of Economic Analysis, while the personal savings rate is now a
few percentage points higher than it was just prior to the beginning of the Great Recession in
2008, it is still much lower than it has been in past decades, indicating that Americans are still
spending more than previous generations (Bureau of Economic Analysis, 2011).

Sources of Information (and Misinformation)

The previous discussion has demonstrated the influence of a consumerist culture on

individual spending habits and offers an explanation. If people are expected to save, we want to
know how they learn about savings, and so we approached the class with this discussion. We
learned that education plays an essential role in the theme of savings and that it occurs in several
different ways. At the same time, many people have misconceptions about how to save. For
example, we discussed in class that people cannot rely solely on Social Security in the future as it
is typically insufficient to cover all of the expenses commonly incurred while in retirement
although it appears that some mistakenly believe that it is possible to do so. A few
miscalculations in the ability to pay for one’s retirement could mean the difference between
buying a luxury good or not, while serious miscalculations can send people into poverty and poor
health.
We learned that people can get information about savings from parents and from
literature. Parents have played a role in this but young people also learn about saving from other
outlets, including personal finance books. One student mentioned that his father gave him a book
titled The Wealthy Barber which guides readers as follows: “Wealth beyond your wildest dreams
is possible if you follow the golden rule: Invest ten percent of all you make for long-term growth.
If you follow that one simple guideline, someday you'll be a very rich man” (Chilton, 1997).
Regardless of whether or not this information is true, the student reported in class that he follows
the advice and it is likely that other readers have been at least somewhat inspired by the book.
Aside from direct financial advice, parents can affect the amount of spending their children have
from deciding to teach them how to prepare meals or fix household appliances. This all depends
upon whether or not the parents have such acquired knowledge and ability. Those parents who
do and choose to pass it along to their children can alter the level of self-sufficiency likely to
occur as their child enters adulthood, thus impacting the amount of money spent on services.

However, one of the classmates raised a problem is conflict of interest: employers do not
want to contribute to employee’s funds. The point here is that employers might not want to
educate workers about retirement savings if that means they have to contribute to the employee's
savings account. The purpose of educating employees is to help them make better decisions, but
the decisions can still be overwhelming and complicated. So you have a trade-off between how
much education is needed and how well the policy will fit the needs of the employee. [we should
talk about the Save More Tomorrow program and move this part there, and then also talk
about the idea of having just a few options as opposed to many in that discussion as well]

The Nudge Category

This section is kind of a catch-all and provides a chance to discuss some of the alternative
strategies in which people save for retirement or nudges that aim to increase savings in general.
Not everyone has the opportunity to contribute to a 401k plan to save for retirement, or even
chooses to do so when the option is available.

The impact of trust funds was a topic discussed in class and how they can affect “Life
cycle” model of saving. The idea of the “Life cycle” model is that young people save for future
consumption and while in retirement they are in a state of dissaving where they consume out of
their savings. This initial accumulation of wealth could be due in part to a trust fund. A typical
time for a person to receive the benefits of a trust fund would be at a younger point in their life
after, around the age of eighteen, and is an example of an expected boost in wealth. Another
example where someone might acquire the benefits of a trust fund would be at the death of a
relative which can prove to be an example of an unexpected boost in wealth. In both instances,
the position of the saving and consumption rates of the beneficiary of the trust fund changes and
that person will have more spending power. Alternatively, not everyone is lucky enough to
benefit from the wealth of a trust fund given to them by their parents and instead have parents
that have accumulated debt in their lifetime. In the latter scenario, a child might have to help
finance the debt of their parents at an early stage of their “Life cycle” as they enter the
workforce.

Another topic of class discussion was the ownership of house or other housing property
as an asset that can experience capital gains and losses. Ownership of a house can be viewed
strictly as consumption but it is certainly viewed by most people as sort of savings investment.
At the end of the twentieth century, the value of houses was rising with seemingly no end in
sight creating capital gains and increased income for the owners. Sure enough, in the beginning
of the twenty-first century there was a burst in the housing bubble and the value of houses fell
creating capital losses and negative income for the owners. Outside of the other financial
complications that led to and followed the burst, the decrease in income from the previously
higher values of houses impacted the expected contribution of income to the retirement savings
of owners. Owning a house is something that a lot people plan on doing and using it as a sort of
investment towards saving for retirement seems to be more of an afterthought.

The discussion about the possibility of hiring a broker or consulting expert advice to
manage savings did not seem to be seriously considered by the class. An explanation for this
could be that the demographic of our class is all college students in their late teens and early
twenties with the possible attitude that saving for retirement is still in the distant future. The
amount of information and options in terms of saving for retirement is arguably inexhaustible
and some people prefer to seek the help of someone to help them navigate and plan for the
future. People procrastinate in seeking advice as in the example of signing up late or not at all
for a 401k plan. In doing so, they are only hurting themselves in the long run. Another reason in
which someone would not want to seek expert advice would be ignorance. They might feel as
though they should not have to pay someone for such a service instead opting to take their
chances at figuring it out themselves by reading their own literature, consulting friends, or just
using the Internet.

An automatic enrollment savings program for retirement was an idea that most people in
the class seemed to be wary of its implementation in the workplace. The reason for concern for
most students seems to be directed against government or institutional paternalism. Respect also
seems to be an important component of an automatic enrollment program. A member of the
class stated that they would be okay with the idea of such a program as long as they are informed
and made aware of the program beforehand.

Saving More Tomorrow

 Thaler and Sunstein (2008) mention a program called Save More Tomorrow which may
help to increase the savings rate in spite of the problems discussed hitherto in this paper. The
Save More Tomorrow (SMT) program combats the problem of inertia while attempting to
dampen the problem of getting people to set aside money for a savings program. The program
“invites participants to commit themselves... to a series of contribution increases timed to
coincide with pay raises [such that] participants never see their take-home amounts go down, and
they don’t view their increased retirement contributions as losses.” In other words, those eligible
for the program would be invited to commit part of their future wage increases to a savings plan.
Thaler and Sunstein argue that because the saving will not be seen as a loss on current
consumption, more people will buy into it. According to their own date, the program has been a
success in that most participants who joined stayed in the program and many people who were
offered entry into the program joined. The authors suggest that because of the program, some
workers saved nearly twice as much as they had before, up to 13.6% of their income (Thaler and
Sunsteain 2008).
We believe that a program like Save More Tomorrow would help increase the saving rate
generally. It appears from our discussion and review of the literature that one of the biggest
problems in saving is getting people to commit to a savings plan, especially when the individual
is faced with alternatives to saving (like keeping up with the latest fashion). Save More
Tomorrow would allow people to decide in a cold state how much to save and would dampen the
effects of saving by increasing the savings rate out of future raises. While many of these raises
would be for cost-of-living considerations, Thaler and Sunstein argue that (despite our
discussion) people do not think about inflation that much when planning out their savings so the
personal impact would not be as great as reducing one’s purchasing power outright.

Work Cited

Chilton, David. The Wealthy Barber: Everyone’s Commonsense Gudie to Becoming Financially
Independent. Roseville, CA: Prima Publishing: 32.

Bureau of Labor Statistics. United States Department of Labor.Economic News Release:

Consumer Price Index Summary. April 15, 2011.
<http://www.bls.gov/news.release/cpi.nr0.htm>

Malkiel, Burton G. A Random Walk Down Wall Street. New York: W.W. Norton & Company,
2007.

Bureau of Economic Analysis. United Stated Department of Commerce. National Income and
Product Accounts Table. Table 2.1: Personal Income and Its Disposition. Last Revised on April
28, 2011.
Deaton, Angus. Franco Modigliani and the Life Cycle Theory of Consumption. Rome Lecture..
March 2005.

Thaler, Richard and Cass Sunstein. Nudge. New Haven: Yale University Press, 2008: 113-4.

Website for the graph:

http://www.federalreserve.gov/monetarypolicy/mpr_20110301_part2.htm