Checking Savings


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Raise the Rate Contest Entry

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Checking Savings

  1. 1. Checking Savings By Mitchell Chubinsky
  2. 2. Analytical Framework Checking Savings Background The Checking Savings Program Conclusion Notes and Sources
  3. 3. Background Recent Trends in the U.S. Personal Saving Rate 0.00% 1.50% 3.00% 4.50% 6.00% 7.50% 9.00% Jan-00 May-01 Sep-02 Jan-04 May-05 Sep-06 Jan-08 May-09 Sep-10 Source: U.S. Department of Commerce: Bureau of Economic Analysis via the St. Louis Fed Personal Saving as a Percentage of Disposable Income
  4. 4. • Although the U.S. Personal Saving Rate has surged in the past few years from alarming lows, it needs to climb even higher. • In these tumultuous economic times, saving early and often is more important than ever: • Volatile equity, fixed-income and commodity markets. • Continued decline of private pension schemes. • Massive deficits in public pension plans and Social Security. • Personal saving is the only way to hedge these risks and an uncertain future. The Current Environment
  5. 5. • It’s clear that individuals should save more; studies have found that many households even feel the same way. • In many respects, low personal savings is less the consequence of economic factors than behavioral ones. • The problem, then, is how can we change people’s savings habits? • A wide body of research has found behavior to be notoriously stubborn; maybe we can’t change it. Raising the Rate – The Problem
  6. 6. But maybe we don’t have to change savings habits…
  7. 7. • Instead of trying to influence consumers’ active savings habits, have banks enroll customers in checking accounts that will automatically transfer a percentage of deposits into linked savings accounts. • Could be pure savings accounts, CDs, govt/agency debt or other risk-free investments. • The deposit transfer percentage would increase 1% quarterly from 2% to 10% (or higher) over two years, driving a comparable rise in the personal saving rate. The Solution – Checking Savings
  8. 8. • This account type would be the default for new accounts, but customers would be free to opt-out at any time. • A rewards program would offer a variety of bonuses for maintaining balances and reaching savings targets: • Higher interest rates, frequent flyer miles, iTunes downloads, etc. • Penalties would be imposed for early and frequent withdrawals not for emergency needs or other qualified expenses. • Housing, educational, medical, etc. Other Features The Checking Savings Program
  9. 9. • Economics predicts that individuals will save a portion of their income while employed to finance a healthy level of consumption after retirement. • People realize that they should save more but have trouble doing so for various behavioral reasons. The Main Idea Analytical Framework
  10. 10. • Bounded Rationality – No one knows for sure what the appropriate savings rate is. The different options and instruments can be overwhelming and confusing. • Those without economics training may not fully appreciate the time value of money or the fundamental tradeoff between present and future consumption. • Hyperbolic Discounting – People tend to irrationally discount the future, overconsuming and undersaving in the present. • Also explains procrastination – I’ll start saving more… tomorrow, when I get a raise, etc. Behavioral Economic Explanations for Undersaving
  11. 11. • Loss Aversion – People tend to weigh losses far more heavily than equivalent gains. Increased savings can be perceived as a loss of disposable income and current consumption, but it’s really just an intertemporal tradeoff. • Amplified by hyperbolic discounting – The benefits of saving for a vague and distant future are severely undervalued, given the cut to spending money that you have to live with now. • Status Quo Bias – There is a strong tendency towards inertia. People infrequently change habits and behaviors, even when it may be in their best interest to do so. Behavioral Economic Explanations for Undersaving
  12. 12. • Using predetermined deposit transfer rates and investments absolves consumers from having to make the potentially confusing decisions of how and how much to save. • Also ensures people will save enough, regardless of behavioral biases and irrationally present-minded preferences. • With enrollment by default and automatic savings transfers, procrastination becomes irrelevant and saving becomes the new status quo. • Discontinuing participation in the plan would require an active opt-out, which few would pursue. Why Checking Savings Will Work Analytical Framework
  13. 13. • Having a preset transfer rate that gradually increases over time from 2% will help ease people into saving by mitigating the loss aversion. • Starting at 10% would feel like a huge loss, whereas 2% would be negligible for many. • Rewards will incentivize and reinforce savings behavior. Offering a variety of bonuses would make the program fun and help expand its appeal across demographics. • Penalties will serve to force participants to think carefully about withdrawals, and in doing so encourage fiscal responsibility. Why Checking Savings Will Work
  14. 14. • Personal Saving Rate. Last Updated 11/1/2010. • • This program draws heavily on the ideas and body of research discussed in Richard Thaler and Shlomo Benartzi’s 2004 Journal of Political Economy article “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving.” • Thaler, Richard H. and Benartzi, Shlomo. “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving.” Journal of Political Economy. 2004, vol. 112, no. 1, pt. 2. Notes and Sources