Sunday, September 21, 2008

Long Term and Short Term

The following article appeared in Business Week magazine recently. I tried to write to them, but their website did not work for me. Here's the link to the original article.

Here's the text.


(It was called "Short-term Thinking May Be A Saver's Best Friend" in the print version)

Financial planners often suggest clients figure out how much they'll need to retire and save toward that huge number. Utpal "Paul" Dholakia, associate professor of management at Houston's Rice University, thinks people would do better to think about how much they'll save next month. A paper he co-wrote with Leona Tam of Old Dominion University found that those who planned savings for the next month did far better than those who tried to plan further out. In one experiment, people said they'd save an average $287 next month but saved $440. When asked to plan ahead four months, they said they'd save an average $946, but put aside just $123. Amy Feldman spoke with Dholakia.

Did the results surprise you? We were shocked. How can someone tell you they will save $1,000 and then only save $100? It's a gross misprediction of behavior.

So we're better off trying to save for next month than next year? That's it. Don't plan in advance because it makes you overoptimistic. You think: "I might get a windfall or a raise." And not only do people who give a savings estimate for four months from now estimate too high but they become more risk-seeking.

Is this just an American problem? We're working with colleagues in China and Korea to see if this translates. In Korea, the young are Westernized, so we think [their behavior] will look like that of Americans.

So here's what I think.

1. The original headline was misleading. It is not about short term thinking. It is purely about decision making and action planing.

2. People use the words forecast and plan interchangeably, but they are different animals. In essence, the short-term savers had a forecast and a near-term action plan. The long-term people had a forecast, but they did not define a path to get there, so they had no plan. In fact, it probably wasn't even a forecast or prediction really, more like a vision. A vision without a defined path for achieving it, including near-term action, is worthless.

3. I can't imagine why the researchers were shocked. Really it's project management 101.

4. I don't disagree that people may hope for a windfall, or take more risk-seeking behavior without a near-term plan. Fundamentally, however, I believe the lack of accountability is the fatal flaw. A numerical plan without a defined set of actions or milestones goes nowhere.

5. Long term thinking sets the context. Planning lays out the path. Budgets tell you what the next step is. Without a long term view of where you are trying to get, you do not know how much to save next month, and also you may lose motivation, (forgetting that you're saving the money for that new car). For people's personal budget, monthly time horizons tend to be best because people typically budget and live on a monthly basis.

I suspect that the researchers understand these things, but the reporters had only a few words to try to condense it. Then they missed the point. Too bad.