Is It Better To Think Short-Term When It Comes to Saving?

The September 15, 2008 issue of BusinessWeek includes a Plus column tidbit titled, Short-Term Thinking May be a Saver's Best Friend. It discusses research by Professor Utpal Dholakia of Rice University and Professor Leona Tam of Old Dominion University—and their conclusion that "those who planned savings for next month did far better than those who tried to plan further out." In one of their experiments, people were asked how much they would save the following month and reported (on average) $287. This in mind, they then went on to save (on average) $440 that following month. But when asked to plan ahead four months, people said they would save (on average) $946 over that time. And they then went on to save (on average) a grand total of only $123—which translates to $30.75 per month. If I've read the experiment description in the article correctly, people concentrating a one-month savings goal did more than 14 times better than those concentrating on a four-month savings goal.

Professor Dholakia indicated he was "shocked" by the results. In advising that people concentrate on saving for the following month, he told BusinessWeek:

Don't plan in advance because it makes you overoptimistic. You think: "I might get a windfall or a raise." And not only do people who give a savings estimate for four months from now estimate too high but they become more risk-seeking.

The risk-seeking behavior seems to include making riskier (and impliedly inappropriate) investments and preferring jobs with high pay but low job security. In other articles reporting on the same study (Study: When saving, it's best not to think long term and Lower Stress by Saving A Little From Each Paycheck), Professor Tam echoed the advice to concentrate on the following month: "[Y]ou have more control over it. You can actually formulate how to do it in more concrete ways." She elaborated:

The easiest thing to do is to be a smarter consumer and make spending and saving decisions thoughtfully on a daily basis — that extra cup of coffee every morning, carpooling with a co-worker and cutting out the 'extras.'

I'm trying to get ahold of a copy of the study to learn more, but so far, this seems like pretty interesting stuff. Though I don't know the details of the study yet, my initial reaction is to take the buzzworthy headlines and synopses advising not to think long-term with a grain of salt. I'd suggest interpreting the study to mean we should approaching savings goals like this:

1. Set a long-term savings goal.
   
2. Break up the long-term savings goal into smaller savings goals (such as monthly goals).
   
3. Look at the savings goal for the upcoming month and make that your focus.
   
4. Consider specific, concrete steps to achieve the savings goal for the upcoming month.
   
5. When you consider your daily spending or saving decisions, think about them in terms of the savings goal for the upcoming month.
   

From the concededly brief news articles on Professors Dholakia's and Tam's study that I've read, this would achieve the gains of short-term thinking—without sacrificing what I would still call the necessity of longer-term thinking. After all, if you are only thinking about the coming month, it may be harder to identify an issue such as a need to make more money that may drive you to reconsider how you look at your current job. And remember, if you follow what I think is one of the best ways to save—automating your savings—this might well shield you from some of the problems revealed by Professors Dholakia's and Tam's study.

Related Posts:

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Four Specific Paths To Automatic Saving and Investing