Prize Linked Savings (you may also see them called 'Save to Win' games) are an interesting take on savings accounts, where every deposit is 'kept' unlike in normal lotteries, but some proportion of interest is assigned to a lucky winner through a lottery. In that way, prize linked savings games hit our psychological love of gambling, while at the same time encouraging people to save.
What's Wrong with the Lottery?
One of the major plights for low-income citizens of the U.S. is the state lottery. The poor are more likely to play the lottery and this portion of society is also known for their very low savings rates, due to most of their income being taken up by mandatory spending. Recently (well, in 2009) there has been an innovation in encouraging those with the lowest incomes to save and it uses the well-trod "lottery" format to do it.
Here's how it works:
You win a savings deposit!
- You save a certain amount of dollars (often in $1,000 increments) and receive a chit for a prize.
- Instead of earning a market competitive APR (for example, 0.80%) you receive slightly lower than average on the savings (in this example, let's say 0.60%)
- The difference is then given away based on a random drawing of one of the chits
Example:
1,000 people save $1,000 each. After one year, they have earned 0.60% in APR (0.60% x $1 MM = $6,000). $2,000 (0.80% - 0.60% x $1 MM) is then given away to one of the savers.
Prospect Theory and Prize Linked Savings
Most of this is predicated on prospect theory and the change in psychology around savings/investing vs. gambling. Instead of paying a large payout to many small negative influxes, the negative influxes (received in forms of lesser interest paid) is on an already positive amount. This encourages those who want to partake savings. The results have been largely positive. States that have implemented policies similar to this have found savings rates increase, especially for those with low incomes.
Other Psychological Tricks Used
For the more astute amongst us, you will realize that this is similar to purchasing a lottery ticket. Each person "paid" $2 in lessened interest over the year for the chance to win money. The only reason this works or encourages good behavior is because of prospect theory, the fact that people value loss higher than an equivalent gain.
How about some other psychological tricks that are used?
One I use on myself is to 'pay myself first'. This can work with 401(k), separate savings accounts or in a number of ways. The key is to take the money that you plan on saving per paycheck first. This creates the illusion of scarcity in your checking account. With a lower checking account amount, it forces you to prioritize spending less. Even though it is mathematically equivalent, by using this method I feel that I trick myself into feeling strapped for cash at all times, thus reducing my spending. This is essentially the premise behind You Need a Budget, a piece of budgeting software that uses the philosophy of assigning each dollar from your paycheck a "purpose" before it is officially spent.
Another psychological trick I use on myself comes in regards to how I follow the stock market. Psychologically, I recognize it is not that helpful to constantly be reviewing and re-reviewing the stock market performance, but I just can't help myself. I am a cheerleader standing by gently coaxing the market along. What I've recognized, however, is that I am cheering whether it goes up or down, helping me maintain my buy-and-hold strategy. If the market goes down, "Good! I can now buy stocks at a discount!". If the market goes up, "Wow! Look at all this extra earnings I've received." It certainly feels irrational to me to cheer two polar opposite outcomes, but in the long term it will hopefully prevent me from panic selling.
What other psychological tricks do you use to help your savings rate/investments/PF lifestyle in general? Do you like the idea of prize linked savings and save to win games?
Cheers,
Cameron Daniels
