Given the choice between placing your savings in an account that allowed you to withdraw your money at any time, or one that either penalised you severely for early access or denied it completely, which would you choose?
You might think that most people would want greater flexibility when it came to their savings, but a new study by academics John Beshears, James Choi, Christopher Harris, David Laibson, Brigitte Madrian and Jung Sakong, is suggesting the opposite.
When asked how they would allocate $5,000 in savings, participants were given three types of accounts to choose from. The first allowed you to withdraw funds at any time. The second account penalised you 10 percent if you withdrew funds within the first year. Meanwhile, the last account restricted any withdrawals within the first year.
The researchers found that most people (approximately 80 percent) put at least some of their money in one of the two restrictive accounts. They further observed that when managing all three hypothetical accounts, the account that prohibited early withdrawal received twice as much as the one with the 10 percent penalty.
It turns out, for those trying to save, restrictive accounts could be the best option.
Saving Yourself from Yourself
Many people are aware of how they can become their own worst enemy when it comes to trying to reach financial goals, like saving for retirement or for a home. With so many temptations to spend, people choose restricted accounts to protect their future selves from their present behaviour.
Economists call these accounts a commitment device—something that locks you into acting in a way you might not otherwise, but which produces a desired result. In this case, by making it costly (or impossible) to withdraw funds from your account, you are forced to save more.
Real-world examples show the power of commitment devices when applied to savings. A survey published over a decade ago found that families with restricted accounts grew their savings by 337 percent compared to the control group. Their savings grew because they were not able to spend. By removing the option to choose how the money could be used, people didn’t have to weigh future goals against present wants.
Other scientists have proven this concept with a creative experiment. In the study “Increasing Saving Behavior Through Age-Progressed Renderings of the Future Self”, participants’ images were digitally altered to show how they would look decades later. Seeing these age progression photos, the findings show, “leads to lower discounting of future rewards and higher contributions to saving accounts.” In short: making our future look real encourages us to save.
More people are awakening to the truth that willpower alone might not be enough to help them reach their savings goals. Rather than fight against their nature, they are choosing to remove self-control from the equation entirely.
Making Restricted Accounts Work For You
Over the short-term, fixed deposit accounts are viable restricted accounts to help you meet your goals. Not only do they offer penalties to deter early withdrawal, but they also offer higher interest rates than regular savings accounts (most of which have rates below one percent).
The steady, predictable accumulation of interest allows for easy planning. Many fixed-deposit accounts have terms from one to five years, with longer term accounts yielding higher returns. By laddering fixed-deposit accounts you can balance having access to your money at regular intervals with taking advantage of higher interest rates.
Many savers are learning that fixed deposits offer predictability because they exclude the intrusion of the person most likely to abort a savings regimen—you.