ADRIAN GORE: Incentives can help change South Africans’ bad saving and spending habits
Research shows that millennials spend more on coffee than they do on retirement savings
There is a considerable opportunity to improve South Africans’ financial behaviour and health. Research shows that we are uniquely inept at saving (too little) and borrowing (too much) — leaving us overindebted and dangerously exposed in both the short and long term. The challenge is that changing behaviour at the individual level is extremely difficult.
As humans, we have biases that conspire against our frequent good choices. Owing to our over-optimism and propensity to discount the future for the present, we are bad at making good long-term financial and health decisions in the present. Instant gratification (eating that slice of cake, buying that unnecessary item) and misplaced optimism (it probably won’t happen to me) mean prudent choices aren’t necessarily easier choices.
Discovery’s research shows this conclusively and pervasively: we think we are in better health than we are; we assume we are better drivers than we are; and 64% of our surveyed members who are in poor financial health rated their financial position as good, very good or excellent. These biases matter because they manifest as cognitive flaws that undermine our financial preparedness.
South Africans borrow more than we should, and at a rate above the global adult borrowing average. In fact, despite its lack of affordability, credit use is outpacing employment growth in the country.
When secured debt is used to purchase assets like homes and cars, the use of debt is rational, assuming there is a justifiable need for the asset and sufficient income to cover repayments. However, this is not the case when expensive unsecured debt is used to fund consumption. When we consume more than we earn, interest and repayment costs grow as more debt is taken out. This increases the debt required to maintain consumption and cover finance costs, which creates a recursive and destructive spiral.
When we engage in this type of behaviour we are either irrationally forecasting our consumption to drop dramatically, which is unlikely given the inflationary nature of lifestyles in the age of consumerism, or we are assuming an implausible salary increase to afford the cost of debt.
As an example, to sustain a financial state in which we need to increase our unsecured debt by 10% of our monthly income our salary would need to become nine-and-a-half times larger over the next 10 years. This is in relation to the increase of about two-and-a-half times what would occur with standard salary inflation of 10%.
Recognising the unsustainable nature of using unsecured debt to fund day-to-day expenses would make us reassess our lifestyles and reconsider what we define as need vs preference, thus leading to responsible budgeting.
In the short term our markedly low savings rate (just 0.3% of disposable income) means there is an insufficient buffer in the event of emergencies. In fact, less than 20% of the country’s breadwinners can afford a modest unanticipated expense given how poorly we are covered. This is illustrated by the fact that 65% of cars on the road in SA are uninsured. This lack of preparedness is driven in part by an underestimation of high-frequency, low-probability events occurring, like unexpected medical procedures or car accidents. This makes us less likely to protect ourselves against expensive events, which we mistakenly think will not happen to us.
As an example, if I told you there was a one in 90,000 chance that you will have an accident for every kilometre you drive, you would perceive yourself as fairly safe on the road. However, examining how many times you are exposed to this event paints a different picture altogether. The average couple drives 100,000km in three years, which equates to the risk of an accident every 2.7 years. Significantly, Discovery’s research puts the average accident cost at R26,000. If we recognise that the “rare and unlikely” events are almost certain to happen over time, we would save more, expand our coverage, or both.
Because of hyperbolic discounting and instant gratification, we are bad at making the trade-off between consuming now and receiving the benefits of compound interest over the long term. This is catastrophic because we erroneously perceive our savings to yield linear reserves over time, when time actually has tremendous and disproportionate value.
As an example, each rand we save towards retirement when we are 25 years old is 30 times more valuable than a rand we save when we are 55. This is deeply concerning given the behaviour of our youth. Take millennials: Discovery’s research shows that they spend more on coffee than they do on retirement savings. In fact, 25- to 30-year-olds are three-and-a-half times more likely to cash out their retirement savings when they change jobs. Recognising the affect of compound interest on long-term savings would propel us to save more when we are young and consume the fruits when we are older, instead of the opposite, value-erosive approach.
Our financial preparedness is further hampered by dangerously underestimating the amount of time we will spend in retirement. Most of us fail to grasp that the longer we live the longer we are expected to live. Life expectancy is an average, and by virtue of ageing in good health we have surpassed the age-related risks that would rob us of life years, extending our lifespan as we go. For example, at birth an adult male can expect to live to 79. Once he reaches it, however, there is a good chance he will live to 84, and so on.
With medical advances life expectancy is getting longer. According to our rudimentary calculations — given that mortality improvements have a compounding effect — a 1% improvement applied from birth to age 80 could add an additional nine years of life. The added years dramatically affect the salary percentage a middle-aged worker would need to devote to retirement savings to provide for a 70% replacement ratio (proportion of salary at time of retirement) at age 70.
Compounding this is the increased disease burden at older ages, and the guarantee of medical inflation consistently exceeding the consumer price index, and wage inflation, known as the Baumol effect. This means post-retirement health-care costs will consume increasingly more of our savings with every year lived, with devastating effects in the extended-life scenario. Recognising the nature of life expectancy and the all-consuming cost of growing old given the inflationary price of health care would prompt us to save more, sooner.
Given the state of South Africans’ financial health, the case for disruption is strong. New banking business models can help address this by incentivising better financial behaviour in a way that reverses biases and cognitive flaws.
Furthermore, dynamically linking behaviour to consumers’ cost of banking would deliver the transparency and consumer-centricity South Africans have long argued for. In this way, everyone wins: consumers benefit from improved price, benefits and wealth; banks benefit from lower risk (fewer defaults, greater retention); and society benefits from less reliance on state and greater disposable income. The bank offering becomes less about how much you have, and more about how well you manage it.
• Gore is CEO of Discovery.