If you’re like most Americans, you probably have a tough time saving as much as you should. Part of the problem may be that you do not know how much you need to save, or perhaps you have trouble quantifying the future value of your current savings.

Reality vs. Life Cycle Theory of Saving

Traditional economics supports the life cycle theory of saving, which holds that people plan for retirement by balancing saving and consumption so they can live the same way whether they are working or retired. This theory implies that most people will retire comfortably by adjusting both their savings and consumption to meet their future needs.  

The reality, however, is that many Americans are unprepared for retirement because foregoing current consumption in favor of saving takes a lot of self control. Although few people save enough, behavioral economics does suggest ways to make saving easier from a psychological standpoint.  

Savings & Willpower

In order to better understand the challenge of saving, it is important to understand how most Americans save money. Middle class Americans have historically saved money in three main ways - social security, home equity, and pensions.

These forms of savings are all popular because they don’t require much willpower. Social security and defined benefit pension plans involve mandatory contributions. Although building home equity requires discipline, once a home has been purchased the amount of willpower necessary to stay current on mortgage payments is minimal.  

Utilizing all three of these savings vehicles typically leads to a comfortable retirement, but many Americans no longer have access to traditional, defined benefit pension plans. Many companies have switched from defined benefit plans to defined contribution plans, where willpower plays a much bigger role.  

401(k) plans are one of the most popular types of these defined contribution plans that allow participants to individually decide how much to contribute. Unfortunately, few 401(k) participants actually manage their plans well enough to achieve the same level of saving that defined benefit plans provide.

An Innovative Approach to Increasing Defined Contribution Savings

Promising increases in savings rates have been achieved through the use of Save More TomorrowTM (the “SMarT plan”) an innovative program designed by Behavioral economists Richard Thaler and Shlomo Benartzi. By allowing 401(k) participants to commit to more future savings, the SMarT plan gives people a chance to commit to increased future savings without reducing their current standard of living.

The results from the program are very encouraging. In one form, participants committed to increasing their savings rate by 3 percentage points per year, beginning with their next pay raise. This yielded tremendous results – those that joined the plan tripled their savings rates in only 28 months.  

In another form of the plan, participants could choose to annually increase their future savings rate each year by 1, 2, or 3 percentage points, regardless of pay raises. With this method, the average participant already enrolled in the 401(k) plan increased savings by 1.5 percentage points per year with the SMarT plan. The results indicate that tying increases in savings rates to pay raises is an extremely effective way to increase retirement saving.1

Do It Yourself

Unfortunately, very few employers offer innovative savings programs like the SMarT plan. But how hard would it be to create a similar savings vehicle on your own? It might not be as hard as you think. You can approximate the SMarT plan simply by forcing yourself to increase your savings rate by 3 percentage points the next time you get a pay raise. The process won’t be automatic and it will require both willpower and foresight to both make the initial increase in savings and to follow through every year thereafter. But, over time, the effects will be large. If you’re already maxing out your 401(k) plan, you can setup an automatic bank transfer to make savings less discretionary and more automatic. Is this as easy as the automated SMarT plan? Certainly not, but for the chance to triple your savings rate in the next 28 months, wouldn’t it be worth a try?

You may find that some assistance would be helpful in order to ensure that you properly execute your savings increases. If you do, consider finding a CERTIFIED FINANCIAL PLANNERTM professional from the Financial Planning Association® that can help you setup a program of future savings increases.

FPA member David Zuckerman, CFP®, CIMA®, is Principal and Chief Investment Officer at Zuckerman Capital Management, LLC in Los Angeles, CA.  He serves as CFP Board Ambassador and Director at Large for the Los Angeles chapter of the Financial Planning Association.



1Thaler, Richard and Benartzi, Shlomo (2003), Save More TomorrowTM: Using Behavioral Economics to Increase Employee Saving


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