To save or spend?
My wife and I are having a difference of opinion on saving. We've built up a good lump-sum and she wants to spend it on a family holiday. I think we need to add to our Kiwisaver accounts and invest in a term deposit so we have some money behind us for the future. We need to build up some investment returns. How do I convince her to pull back a bit and not blow it all?
You'll be pleased to know there is a bit of interesting science behind her blow-it-all symptoms. I think we can fairly confidently diagnose your wife with a dose of 'hyperbolic discounting'. It's about as widespread as the common cold, but unfortunately a couple of panadol doesn't suppress it.
On the flip-side, she's probably diagnosed you with a dose of miserable husband syndrome, but I'm more comfortable dealing with her problem than yours.
What is hyperbolic discounting?
Hyperbolic discounting is the flash term given to the way we compare the value of getting money today, versus waiting for a bigger amount. Apparently, we're a pretty illogical bunch and the maths-geeks had to design a special hyperbola shaped curve to show how our decision making isn't consistent.
In the world of economics we will accept a smaller pot of cash if it is paid to us today, than if we receive it in a few months' time. Money has a time value. In this logical world, we apply the same percentage discount to each day we wait. Economists are what we call 'exponential' discounters.
Back in the real world where emotions play a part, our brains implode. We have a bias towards getting something immediately and we heavily discount small delays. As we go forward in time, our brains change and we become more patient. The discount rate lessens.
To see how prone you are to the hyperbolic brain implosion, take this test:
1. If I offer to pay you $100 today or $110 next month, which would you choose?
2. If I offer to pay you $100 in 12 months or $110 in 13 months, which would choose?
Many people will take the approach of a bird in the hand - they'll have the $100 today. In the second example they will choose $110. Yet the choices were the same; there was a one month wait each time. Knowing they have to wait a whole year removes the problem of instant gratification and they suddenly see the value in a small extra period of time.
Those of us with strong hyperbolic discounting tendencies won't apply consistent decision making. We value instant gratification so highly, that we end up almost ignoring future values.
If you are sitting there feeling smug having passed the test and made a consistent decision, don't get too comfy. Hyperbolic discounting will just creep up and get you in another aspect of life. Look no further than your own body shape - do you have a portly belly? Perhaps you are favouring short-term pies and discounting too heavily the greater reward of a longer life and good arteries.
There are many aspects of life where getting on with today and not constantly living for the future is a good thing. Quite often having a holiday fits that category and emotional needs can't be ignored.
So I don't suggest that you sit your wife down and say "honey you've got the symptoms of hyperbolic discounting so I'm taking control of our bank accounts". It won't work and you'll be sleeping in the spare room.
Two things do tend to work. You both need to pretend the decision belongs to someone else. What would you tell them to do? Distancing yourself helps.
Second, put some facts around the future benefits you are giving up. When it comes to money, most of us fail to understand the value of compound interest. When we see it in black and white, we get some perspective and our discounting tendency lessens.
If long term investment returns were 4 per cent a year, each dollar spent now could be worth $2.10 in 20 years or $3.20 in 30 years. At 6 per cent returns over 30 years, you are giving up $5.70 every time you spend a single dollar. Even a 55-year-old needs a 30 year time horizon on a portion of their savings, as it has to last well into their 80s. When you visualise a $10,000 spend-up causing your retirement savings to be worth $57,000 less, it makes you think.
Mr Exponential and Mrs Hyperbolic
Couples tend to benefit from gender differences, because our preferences force us to analyse things more fully. Sure we rub each other up the wrong way over financial matters, but it's good to consider all the angles as it generates a better decision.
Nothing beats a good survey to point out some of our gender bias. The British government-owned bank, National Savings & Investments discovered that:
* 41 per cent of women are motivated by short-term savings goals like saving for holidays, where as only 29 per cent of men like to save this way.
* 53 per cent of men say their main reason for saving is either for retirement or in case of an emergency (longer term goals). Only 33 per cent of women have the same view.
Whether you are a hyperbolic holiday spender or an Exponential emergency saver doesn't really matter, nor does it matter which gender favours short or long term decisions. Every family needs a balance of goals. A financial decision will only make you happy if it has both logical and emotional input.
Email questions to firstname.lastname@example.org, subject line: Financial Agony Aunt. Anonymity is guaranteed.
Janine Starks is Co-Managing Director of Liontamer Investments.
Opinions in this column represent her personal views and are not made on behalf of Liontamer. These opinions are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.