Essays on retirement accounts savings and investment behavior
Yuan Yang, Purdue University
Voluntary retirement plans, such as defined contribution (DC) plans, and Individual Retirement Accounts (IRAs), have grown rapidly in the last two decades. Individuals can make decisions on whether to enroll in the plan, how much to contribute to the plan and how to allocate assets within the plan. The factors that affect individual’s participation, contribution and investment decisions are investigated in two essays. The 2004-05 MacroMonitor data are used for the analyses in both essays.^ The first essay examined the determinants of retirement plan decisions including participation and contribution in DC plans using a double hurdle model. In addition to age, income, marital status, education and occupation, workplace financial planning benefits were an important factor affecting participation in and contribution to a DC plan. The results suggest that interventions including information and social interactions, as well as financial literacy and education played an important role in retirement plan decisions. The results showed different effects for gender and risk tolerance in participation and the amount of the contribution. Women and risk averse respondents were more likely to participate than their counterparts but they contributed smaller amounts. ^ The second essay built an investment risk-taking behavior model by integrating risk-taking behavior in a theoretical framework of perceived risk processing and tested the model in the context of investment in IRAs. The findings of analysis using a Structured Equation Model supported the proposed model. Search for financial information served as an input of perceived risk. Individuals who were more experienced in information search tended to perceive a lower risk toward stock investments. Also, perceived risk negatively affected risk-taking propensity in financial investments. Finally, risk-taking propensity impacted risk-taking behavior. People with greater risk-taking propensity preferred riskier choices and allocated their IRA investments to stocks. In addition, individual risk profiles including financial self-efficacy, investment time horizon, wealth and gender played an important role in perceived risk processing. Financial self-efficacy, investment time horizon, and the level of wealth had a negative effect on perceived risk but a positive effect on consumers’ risk-taking propensity. Compared to men, women had a lower level of risk-taking propensity in financial investments.^
Sharon A. DeVaney, Purdue University, Richard Widdows, Purdue University.
Business Administration, Marketing|Economics, General|Economics, Finance
Saving money. It’s something everyone knows they should do. So why does it seem so difficult to get started? The fact is everyone has to start somewhere, and starting is the hardest part. Having liquid savings is something that might impact you in ways you hadn’t thought of.
We all know how important having an emergency savings is in an emergency, but think of the decrease in stress when you have some money set aside. Think of the discipline and confidence you’ll gain in making a savings plan and sticking to it. If the worst happens and you lose your job, money in the bank is the difference between living off of high interest credit cards and having a safety net to pay your bills. A savings account is the first step to building a better financial future for you and your loved ones.
Why People Save
The uncertainty of living paycheck to paycheck is a real fear that affects millions of Americans, especially with the volatile economy and job market in recent years. Money in the bank is peace of mind, something that won’t fluctuate if the market crashes or the economy sours. Whether it’s for an emergency fund, saving for a vacation, or buying a home, a savings account should be a priority on everyone’s financial “to-do” list. Think of savings as a way of paying yourself first. People are used to paying bills, and a savings account is no different. Think of your monthly savings goal as a bill that has to be paid just like any other. If your cell phone bill is $100/month do you always find a way to pay it? Of course. So if your goal is to put $100/month into a savings account you should treat it like a bill and make sure it gets paid!
How to Start Saving Money
The first step is to set up a savings account. Whether it’s online or at a physical bank down the road, don’t get overwhelmed with all the options. Pick an account that has minimal fees, no minimum balance, and if possible, a decent interest rate to start. Rates are low right now, so if you find an account that doesn’t have fees you’re already ahead of the game.
Opening up an account with an online bank is usually the quickest and easiest way to get started. The application process can be done 24 hours a day and usually only takes a few minutes. You can usually fund the account with a small opening deposit (usually around $50, though some banks require a little more or less) transferred instantly from your existing checking account. Once your savings account is linked up with one of your existing accounts transferring money is as easy as a click as a mouse. In fact, you can even set up scheduled and recurring deposits so that it’s all done automatically. Ally Bank is currently offering one of the highest rates.
If you’d prefer to go in person it’s still a simple process that should take less than 30 minutes. You can stop into any branch office of your existing bank or a new one and let them know you’d like to open an account. In the end it doesn’t matter so much where you bank as it does just setting up an account somewhere and actually putting it to work.
Building Your Savings
Once the savings account is set up it’s time to start focusing on building your savings. The most intimidating part of beginning to save money usually stems from looking at the big picture before focusing on smaller goals so that you know what you’re up against. Financial professionals often recommend having 3 to 6 months of emergency expenses in savings. That’s a big chunk of cash and most people are not going to be able to save that kind of money in a short amount of time, and no one expects you to. Here are some more ideas on how to save money fast if that is your ultimate goal. This is the big picture so don’t try to bite it all off at once.
Instead, break your goals into smaller, more sizable benchmarks. Try having 10% of your salary direct deposited into your savings account. Direct deposit means you won’t see the money hit your checking account first, and therefore will probably be less inclined to spend it. If 10% is too much to start with, begin with 5% and increase the percentage by 1% every three to four months. If you receive your paychecks via paper check, discipline yourself to taking a percentage of that check and physically depositing or transferring the equivalent amount into your savings whenever you get paid.
Don’t get discouraged in the first few months. Remember, if you’re depositing just small amounts and earning little interest it won’t seem like you’re making progress, but you are! Periodically, check your progress to make sure you’ve been saving as much as you should. The goal doesn’t have to be a dollar amount, but every quarter or every six months, make sure you’ve been keeping up on your savings plan. This can be as informal as a simple spreadsheet to as detailed as you want by managing your accounts in something like Quicken. Tweak your progress periodically to reinforce your savings goals or plan for upcoming expenses. If you receive a bonus, put the same percentage straight into your savings account. Remember, pay yourself when you receive income, whether from a gift, a bonus, side income, or tax refund. Continuing to reinforce the pattern of saving only puts you closer and closer to meeting your goals.
Stay on Track Once You Start
Keep yourself on track with your saving and the rewards will be tremendous. The biggest thing is to keep from getting discouraged. Most people take years to build up a savings fund, and having a small amount of money in the bank is better than having none at all. It’s easy to feel like saving just $20/week or something isn’t doing any good, but remember that you’re setting a plan in place that will likely take a few years to reach your goals. It’s a marathon, not a sprint.
Eventually, you’ll check your progress and be amazed at how those small steps towards saving have turned into a sizable balance in your savings account. It takes discipline, patience, and maybe even some steps towards more frugal living, but the rewards of building a cash cushion will be well worth it. The peace of mind of having a savings account is, in a word, priceless. So, what are you waiting for?
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.