(June 2020) There are several puzzles when it comes to saving which the standard life-cycle model cannot explain. According to this model, households accumulate assets during working life and subsequently decumulate them in retirement. However, within this standard model it is a challenge to explain why older households could try to avoid utilising their housing wealth to fund their spending, even when they seem “house rich but cash poor”.
Nonstandard preferences, such as temptation and self-control, may help to explain a taste for commitment in investment decisions. For instance, a common temptation is to spend all available financial resources (“cash on hand”) on current consumption, instead of choosing to save to fund future purchases. Temptation preferences affect the decision to invest in illiquid assets (such as retirement accounts) or housing, because the funds in such assets cannot be accessed immediately. Indeed, holding illiquid assets could be a way to resist the temptation to spend cash on hand. Therefore, Angelini et al. analyse whether a desire to control temptation could be affecting households’ decisions to hold long-term savings instruments and increasing the likelihood of purchasing housing.
SHARE provides information on households’ assets choices
For the purpose of the present research, microdata from the third wave (2008) of the Survey of Health, Ageing and Retirement in Europe (SHARE) were used. This so-called SHARELIFE dataset provides household-level information of respondents aged 50 and over, including holdings of illiquid financial assets, housing, ownership and accumulation of assets over lifetime. Alongside these financial variables, the authors also used information from the second (2006) wave of SHARE on demographic characteristics, income, and risk attitudes, and exploited data from 12 European countries.
Controlling temptation enhances housing investment
Angelini et al. found consistency between the predictions based on “temptation preferences” and the observed patterns of investment in both illiquid assets and housing. Their study provides evidence that tempted individuals invest in illiquid assets to control their temptation. Housing is a common commitment device, particularly when age or other factors mean that accumulation in pension schemes is less relevant. Different levels of temptation across individuals may explain the variation in illiquid investment before buying a house. Another explanation raised by the authors to describe this heterogeneity is the discrepancy of institutional features across Europe that shape the financial markets and access to financial instruments.
Further research could give insights into purchasing decisions
Understanding saving and investment decisions of individuals not only has an academic interest but is also important for pension practitioners and has policy implications in ageing societies. Further research could explore more reasons why individuals invest in housing after purchasing illiquid assets, specifically looking into the relationship between the commitment effects of temptation and factors such as limited access to financial markets and credit constraints.
Study by Viola Angelini, Alessandro Bucciol, Matthew Wakefield and Guglielmo Weber (2020): Can temptation explain housing choices over the life cycle? The Manchester School 88(2): 229 – 261. DOI: 10.1111/manc.12304. First published online: 02 October 2019.
URL: https://onlinelibrary.wiley.com/doi/epdf/10.1111/manc.12304
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