How inertia helps improve savings

You should preferably have default choices for your investments. By this, we mean you should initiate action today such that you routinely save money every month and the savings are automatically transferred into investments. Why are default choices good?

Research in behavioural psychology suggests that we find it difficult to take decisions because of inertia. If you like tasty but unhealthy food, you will agree that it is not so easy to break the habit and eat healthy but not-so-tasty food. Similarly, all of us like to spend. So, monthly savings becomes difficult, even though we know savings is good for our long-term wealth.

Default choices take advantage of our inertia and make us better-off over the long term.

organ donor programs

Consider this. Two countries, Germany and Austria, have different experiences with their organ donor programs. Austria has near 100 per cent enrolment where the citizens give permission to the state to harvest their organs after their death. In Germany, far less individuals consent to organ harvesting. How do you explain the difference?

Both countries follow a different default choice- Austria follows presumptive consent approach while Germany adopts explicit consent. That is, Austria presumes that its citizens consent to organ harvesting.

If any individual feels otherwise about donating organs, he or she can opt out by simply checking a box in a certain form. In Germany, an individual has to check a box in a certain form to consent. Now, individuals in both countries do not check the box.

The result is that most individuals unintentionally consent to organ donation in Austria while only few explicitly consent in Germany! Likewise, we want you take advantage of your inertia to improve your savings habit. Consider the systematic investment plan (SIP). You should give a written consent to a mutual fund company to debit your bank account every month.

debit instruction

You can convince yourself that you can stop this debit instruction whenever you want to. But stopping the debit instruction requires effort.

And because of inertia, you are unlikely to give a stop instruction anytime soon. Your inertia, therefore, helps you accumulate wealth.

You should also have a default choice to increase your savings. Increasing savings today is difficult, as it would mean cutting your current consumption. But increasing your savings when your salary increases is easier, especially if you commit to doing so today.

Remember, a promise today to diet from next week is easier than to actually diet from today.

You should, however, create devise a commitment today as a default choice so that a portion of your salary hike, when you get one, automatically transfers to your investment account.

(The author is the founder of Navera Consulting. Feedback may be sent to knowledge@thehindu.co.in)

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