Alex Tabarrok has an interesting discussion of saving strategies. Alex writes:
There are people who don’t save much because they have very low incomes, their behavior does not seem to be in error, especially when we take into consideration the various welfare programs that will cover people in their old age. . . . So let’s focus on people with moderate to high incomes. . . . Overconfidence and in particular, the idea that we are special and will live a long life suggests the error is saving too much. . . . Availability bias probably also suggests we save too much – we see people who saved too little in the street but the ones who saved too much are dead and gone. . . . I do not know which error is more prevalent but if we are to be neither spendthrift nor miser we need to recognize both types of error.
My guess is that Alex is a little too optimistic about people’s savings strategies, given all the credit card debt out there. After all, many people have had to learn how to dispute collections, or what to do when that collector comes knocking for their outstanding debts. Also, as some of his commentators note, it is easy for people to get used to a particular spending pattern, and it’s easier to ramp it up than to scale it down. There are even credit cards for people with no credit so they can still spend like the rest of us. We have all had times where we have gone out with a tight budget only to overspend, or have a set amount for the month and then need to dip into our savings to make sure we do not go into the overdraft instead. So, for psychological purposes, it might be better to plan for a gradually increasing standard of living than something completely flat over time.
But I’m sympathetic to Alex’s general point that both kinds of errors are relevant. It reminds me of when I asked the students in my decision analysis class to raise their hands if they’d never missed a flight. I then said to them: You go to the airport too early! A retrospective rather than a prospective analysis but still essentially correct, I think.
One of the faults of statisticians is that we tend to think in terms of probabilities instead of loss functions.
Saving too much is not a great loss. Saving too little and becoming destitute can be a very great loss.
If you have ever had to sleep overnight on the floor of the airport, you know that arriving late for a flight can be a great loss. ;-)
(repeating the comment I made on Alex's original post) If you consider the payoff matrix involved in a 2×2:
save at high rate
save at low rate
x
die young
die old
Well, with this matrix it's pretty clear saving more is the thing to do. Being old and poor is to be avoided. Even if you saved a lot and died relatively young, you may leave spouse and kids who will appreciate your thoughtfulness in providing for them. [consider that you don't buy insurance on your life for YOUR benefit, but for THEIRS]
There may be people somewhere who are spending far too little now so they can save up too much for later, but it's hard to believe they live in the U.S.
We "saved too much." And I'm glad we did.
Consuming more than we did would not have made us any happier. We lived well, did interesting things, travelled to interesting places, and enjoyed life. It happens that there was something left over each month, so it got invested and accumulated until it became "too much."
Now that we're retired, we have confidence that we'll have enough to last us. If there's something left over, so what? We also have the pleasure of knowing that it will benefit our kids and certain charities that we support.
So I agree with Kevin Wright. It's much better to have more than you need than it is to be short.
And then there's this:
Money Quote by Charles Dickens
Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
I don't think the students "go to the airport too early". I had an experience being late and it turned out to be a big trouble. If I could, I would choose to "waste" time waiting at the airport rather than have that trouble.
Imagine a situation in which you are likely to lose $100,000 (even the probability is small, say 0.2%), if you can spend $20 to completely eliminate the possibility, I believe you will. The possible loss is so unaffordable that people are willing to pay something to prevent it from happening.
What is this savings thing you speak of? Is that what people did before they had to pay off mad student loans?