John Hoffmire: A way to increase the savings rate in the US
Editor's note: Ben Young wrote the vast majority of this article.
As 2014 begins, all across the world the rush of New Year’s resolutions has crested. Many of these resolutions involve getting a better job, working harder or simply saving more. One common goal is developing a so-called “Rainy Day Fund”: extra cash available in case of emergency. Yet, for the majority, this fund never materializes and the goal is forgotten. Alas, the rain does come.
But what would happen if people had to come up with money quickly? Peter Tufano, dean of the Saïd Business School at the University of Oxford, along with his co-authors, conducted a survey about preparedness and savings. The main survey question was simple: “If you had to, would you be able to come up with $2,000 in 30 days?” A staggering 46 percent of Americans answered “No,” while another 7 percent answered “I don’t know.”
For those familiar with economic statistics, this is surprising but not entirely unexpected. The personal savings rate in the United States had been steadily declining for the past two decades. In 2012, Americans saved at an annual rate of only 4.1 percent of post-tax income. Pre-tax savings have been increasing, but the ability to use these monies for immediate needs without penalty is restricted by tax laws.
According to figures from the IMF, China’s personal savings rate had become the world’s highest in 2012, at more than 50 percent. It was well above the global average of 20 percent at that time. While one could argue that more spending creates a stronger economy, many believe that more savings is better.
One solution to the saving problem in the U.S., offered by Tufano and his colleagues, is called Prize Linked Savings (PLS), or sometimes Lottery Linked Savings (LLS). PLS is an approach aimed at making saving money not only more fun, but potentially more rewarding as well, combining the social good of saving with the appeal of the lottery.
The basic structure is straightforward. First, a participant deposits money into a PLS account, usually a CD or some similar interest-generating vehicle. Then, for every $25 deposited (or a similar small amount), the customer is entered into drawings held throughout the year for cash prizes supplied by the credit union, using part of the interest generated from the accounts. These cash prizes for saving range anywhere from weekly drawings of $100 to a grand prize of $100,000. And, if at any time the consumer needs money, he or she is free to withdraw the cash plus remaining interest. In essence, it is a win-win situation for the participant.
The potential benefits of a program like this are enormous, especially to the poor and low-income families in our nation. By incorporating the excitement of the lottery without the risk, PLS accounts provide an alternative to the dreadful returns of standard lotteries which, despite the poor odds, remain incredibly popular. Last year, Americans spent $58 billion on the lottery, almost $200 for every single person in the country. The data suggest that the poor spend a disproportionately large part of their income on lottery tickets.
As of now, PLS programs are just getting started in the United States. The most successful program is called “Save to Win” in Michigan, generating above-average savings rates, especially among those in lower-income brackets. A bill is now in committee in the U.S. Senate and the House to ease regulations on bank-funded lotteries to make similar programs possible nationwide. In time, these may come to be a leading means in driving savings, especially among the poor.
On the other hand, it will be interesting to see whether these types of programs simply desensitize individuals toward gambling and lead to even greater problems.
A nonprofit organization, the D2D Fund, started by Tufano and run by Tim Flacke, is helping to lead the charge toward greater use of these programs. It will be interesting to see whether prize-linked and lottery-linked savings continue to grow.
John Hoffmire teaches at SaÏd Business School at the University of Oxford.
Ben Young is a graduate of BYU and currently works as a business analyst for Precoa in Portland, Ore.