Recent speculation about possible announcements in the upcoming budget restricting Cash ISA allowances misses a more fundamental problem according to Greg B Davis, Head of Behavioural Finance, Oxford Risk. In the following analysis, Greg argues that these products are behaviourally flawed to begin with.
Davis says: “By combining emotional comfort with a tax benefit, people are rewarded for holding onto cash, even when investing that money would serve their long-term needs more effectively.
“The average investor loses 2–3% annually from holding too much cash. This isn’t a knowledge problem; it’s an emotional unwillingness to move from what feels safe to what’s suitable.
“Any policy limiting this psychological crutch will ultimately help investors to escape the trap of short-term comfort over building long-term financial resilience and should be applauded.”
Increasing Capital Gains Tax could strengthen psychological lock-in
“Rumours of increases to CGT will naturally magnify emotional tax aversion—the instinctive preference to pay less tax even at the cost of overall returns.
“People naturally want to avoid paying tax, but this instinct becomes problematic when investors stay in unsuitable portfolios to avoid the feeling of loss that comes with crystallising a gain and paying tax.
“Higher CGT rates will amplify this “psychological lock-in.” Investors will increasingly choose to remain in sub-optimal positions rather than face what feels like a loss, even when making changes would improve their long-term outcomes. Portfolios will stagnate for emotional rather than financial reasons.”
Reducing salary sacrifice is a lose-lose for individuals and the economy
When it comes to salary sacrifice however, Davis believes that this… “is behavioural design done right—it makes saving automatic. Proposals to restrict salary sacrifice pensions would hinder a policy that works with human behaviour, rather than against it.
“It’s already concerning how many workers turn down free money by not maximising employer pension matching. Adding friction to automatic saving would be counterproductive for both individuals and the economy.”
