"Would you rather have an easier or a harder time accessing your money?"
How do you think the average person would answer that question? More importantly, how would you answer that question? Most people would assume folks would rather have easier access to their money. Heck, that's the basic premise of mobile banking and debit cards, both of which are very, very popular inventions. As it so happens, classical economic theory would agree with you. According to the old masters, people ought to want more access rather than less.
That's why a working paper by John Beshears, et al., is such a big deal -- it turns this long-held tenet on its head.
Image source: Getty Images.
The study
Researchers ran two separate experiments. In the first, they offered participants cash, and the option to deposit the money into two accounts in whatever manner the participants wished. One account was completely liquid -- meaning that participants could withdraw the moola whenever they wished. This was called the Freedom Account.
The other account was illiquid, although the way in which it was illiquid randomly varied across participants: For some, the illiquid account carried an early withdrawal penalty of either 10% or 20%; for others, the illiquid account restricted withdrawals until a future date. This was labeled the Commitment Account.
Both the Freedom and Commitment Accounts had the same interest rate. Researchers found that participants chose to allocate between 39% and 56% of their money to a Commitment Account depending on what type of illiquid condition was placed on it. Interestingly, more restrictive accounts (the ones that prohibited withdrawal for a set time period) generally had higher deposits than less restrictive accounts (like the one with a 10% withdrawal penalty). That means that more restrictive accounts are more attractive, a result that was wholly unexpected.
If you thought the results of the first experiment were crazy, the second experiment will knock your socks off. Even when the Commitment Account had a 1% lower interest rate, participants still chose to deposit about a quarter of their money in it -- meaning that people valued an externally imposed forced-saving mechanism over making more money.
Know thyself
The good news from this study: Americans have a better grasp of how likely they are to be tempted to make financial mistakes than scientists thought. And that self-awareness is a good thing, because it turns out there are saving mechanisms that can help them out.
It might be time to ask yourself: "Am I prone to being too impulsive with money? Especially money that I know I should be saving?" Look in the mirror and consider whether or not you might benefit from stashing your money in a place you can't get to it.
Some signs that you might need to secure your money from yourself include:
- Creating a workable budget but then blowing through it every week or month.
- Relying on your tax refund as a way of saving money throughout the year.
- Thinking more than once that you'll get around to saving for retirement or paying down that credit card debt at some hazy future date.
Luckily, there are accounts designed to help by making it hard for you to dip into your savings -- with the added benefit of boosting whatever you do deposit! Even if you don't need any help convincing yourself to leave your savings alone, read on -- because these accounts can help you grow your retirement savings via the power of compounded interest and tax breaks.
Restrictive savings vehicles for the impulsive (and not-so-impulsive) person
Three accounts spring to mind when you combine the ideas of restrictions and savings: certificates of deposit (CDs), individual retirement accounts (IRAs), and 401(k)s.
CDs are like savings accounts, but they come with higher interest rates of 1% to 3%. The catch (or benefit!) is that you must agree to let the bank keep your money for a set period of time. That means no early withdrawals unless you want to face a hefty fee. Penalties are typically either a portion of the interest you would have earned, a percentage of the principal, or a combination of both. Terms range between six months and five years, with longer terms equaling higher interest payments.
Although the interest is higher than most savings accounts, it's not as much as you can earn through investing, so think long and hard (and consider consulting a financial planner) about whether CDs fit into your savings and investing strategies.
IRAs -- both traditional and Roth -- are excellent vehicles for retirement saving. Not only do the accounts come with certain tax benefits, but you can also use them to buy stocks and take advantage of the power of compounding interest. In return for all these awesome perks, Congress has made it very difficult for you to take money out of the accounts without facing stiff penalties. This is intentional. Since the accounts were designed for long-term retirement savings, the government wants to incentivize saving and discourage frivolous withdrawals, which makes IRAs great accounts for safeguarding your money from yourself. The only catch is that the contribution limit for IRAs in 2017 is $5,500, or $6,500 if you're 50 or older.
A 401(k) is very much like an IRA, except it's sponsored by your workplace and the contribution limit is $18,000 (or $24,000 if you're 50 or older). Employers frequently offer to "match" contributions to a 401(k) -- meaning that they match however much an employee deposits into an account, up to a certain percentage. This helps boost the power of your retirement savings. Like an IRA, 401(k)s typically come with favorable tax benefits and can be used as a vehicle for investments. A 401(k) can be an invaluable retirement tool. Make sure to take advantage of it, if you have access to one!
The best thing about all these accounts is that they'll encourage you to stay disciplined when it comes to retirement saving. You can't raid the cookie jar without facing some serious penalties, and the accounts come with attractive incentives to help you build your hoard. It's truly the best of both worlds when it comes to retirement saving. But all the mind tricks in the world won't help you if you never get around to saving, so make sure that you start planning and saving as soon as possible.
