Many people take no care of their money till they come nearly to the end of it, and others do just the same with their time.
Johann Wolfgang von Goethe
To save or not to save? That is the question. Surely, you have talked about saving more than once, but do you really know what it is? Every time we receive income, we make decisions about it: most of it we allocate to consumption and payment of debts and a small part of it we save or invest for future use.
On this occasion, from Steering Bird, online advisers in business direction and management, we will talk about savings money and some factors that determine it.
To get into the matter
Save your money. You’re going to need twice as much money in your old age as you think.
According to Investopedia, saving is “the money a person has left over when they subtract their consumer spending from their disposable income over a given time period. Savings can be used to increase income through investing”.
This definition corresponds to the Keynesian theory of consumption. Now, according to the neoclassical school, saving depends on the interest rate, which manages to balance saving and investment, since they postulate that money is only a medium of exchange. Other theories postulate different factors, but for simplicity we will keep the conception made by John Maynard Keynes.
That is, savings is the balance that we do not spend of our periodic income, such as monthly income. The above works very simple. Saving is inversely proportional to consumption: the higher the consumption, the lower the saving, since income is limited.
There is another inversely proportional relationship, which we take from neoclassical theory, between saving and investment, and it is associated with the interest rate, which encourages or disincentives saving over investment. Regarding investment, we invite you to read our article 10 tips for investing.
For practical purposes, the majority of the population receives their income, generates their consumption expenses and, if there is something left, they use it for savings.
Some factors that determine savings
Money often cost too much.
Ralph Waldo Emerson
Beyond defining savings as the balance of income after consumer spending, there are some critical factors that incentivize or discourage savings. Here we name 5 of them:
- Your current income level: In theory, the higher your current income, the more you will save, since your consumption needs will be covered quite easily. In practice, there are several factors that condition you otherwise. In this way, the higher your income, the more you increase your consumption, so that in the end you do not increase your savings levels much. Still, the higher your current income level, the more likely you are to save.
- The magnitude of your future income: If you expect future income to be greater than current, it is difficult to save, because you will expect to save later. Conversely, if you expect future income to be lower, you will be more likely to save now. If income is uncertain, you also have a greater incentive to save.
- Your projections or forecast: If your forecast is very optimistic, generally you will trust yourself and you will not leave place for savings in future planning. If you are very pessimistic, you may just think about covering expenses and not consider saving. Everything will depend on how you value future expectations.
- Your expectations about future prices: In theory, and on the basis of rationality, if you expect future prices to be higher, you will have a greater tendency to save. If you expect them to be less, you will have less tendency to save. Regarding this, we invite you to read our articles about the Futures Market.
- The Money Illusion: We have already told you about the Money Illusion in the article Inflation vs Stock Market (part 2). This phenomenon makes market agents, acting in nominal and not real monetary terms, make incorrect decisions about consumption, investment and saving. Thus, the higher the inflation, the more distortion there will be in these decisions.
The negative savings trap
Never spend your money before you have earned it.
As we have mentioned, saving is what remains after your consumption expenses. In economic terms, it is called positive saving… then, is there a negative saving? Unfortunately, yes. It is also known as dissaving.
Negative saving is not about spending your existing savings, which is why you are saving it, but it is a slightly more perverse concept. As defined by Investopedia: “Dissaving is spending money beyond one’s available income. This may be accomplished by tapping into a savings account, taking cash advances on a credit card, or borrowing against future income via a payday loan.”
That is, every time you use your credit card or request a credit from your bank, you are generating negative savings or dissavings. We already told you before that the payment of debts is deferred consumption, but strictly speaking, it is to pay your previous negative savings.
Thus, dissaving is a trap from which it is difficult to get out. For example, if in period N you dissave EUR 10 and when you reach period N + 1 you have not changed your consumption level, you will have a negative saving of EUR 20 (the payment of the negative savings of period N and the new one of period N + 1). This will keep growing like a snowball.
In practical terms, negative saving is taking a level of consumption above the possibilities, leading to chronic debt or impoverishment.
Why don’t you save enough?
Do not save what is left after spending, but spend what is left after saving.
So far, we have talked about saving, defining it as the balance of your income after your consumption expenses. We have also indicated some factors that determine your willingness to save, which in economics is called “marginal propensity to save.” These factors include your current income level and your expectations for your future. This last point is very important, as it is the uncertainty factor that affects your current decisions. We also tell you about dissaving or negative savings.
In previous articles, we have talked about psychological anchors, the effect of luck, the fallacy of planning and how we make our budgets and forecast. Generally, an excess of optimism about future affects our current decisions, such as consumption, saving and investing. Sometimes there are unforeseen factors that affect our situation, such as the coronavirus crisis. The income level and the influence of these factors, among others, will lead you to answer: Why don’t you save? Why don’t you save enough?
Saving allows you to face situations that you have not foreseen. That is, the failures in your expectations, budgets and forecasts. Saving forms, the basis of important decisions for the future: strong investments, travel, studies, support for pension plans, etc.
No less is the role of the media. When was the last time you saw an advertisement about savings? When was the last time in a movie or television series you heard the word savings? While you think, we will tell you that both consumption and dissaving appear at every moment. Let’s remember how easy it is to make decisions guided by psychological anchors.
Try to save, it is important. But more important is that you are not a victim of dissaving.
Now, what if you change the paradigm? Stop considering savings as the balance of your income after your consumption expenses. Begin to consider consumption as the balance of your income after setting aside an amount to save. Make saving money a priority. Try it and you will see how everything begins to change.
We are Steering Bird, online advisers in direction, management and finance. We specialize in business analysis, control and analysis of investment projects, results analysis, processes of budget and forecast, etc.
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