It is important to make good financial decisions when planning for retirement.
Although people have good intentions about how and when to save, left to their own devices, they fall prey to certain biases when making financial decisions. In this article, we’ll address additional obstacles and introduce some solutions to work around these issues.
Self-control
Even those who have the computational skills to solve the problem and recognize the need to save more, many lack the self-control or will power to reduce current spending in favor of future benefits. There is a constant battle being waged in the human mind between getting an immediate reward and being patient in order to receive a better one in the future. The lure of instant gratification often trumps making the smart long-term decision.
For those who expect pensions and Social Security to provide sufficient retirement income, self-control plays a minor role because neither requires will power to save. The employer and government do it by default. Unfortunately, as old-fashioned pension plans disappear, and Social Security replaces less of pre-retirement income, fewer Americans find themselves in this category.
Each of us is born with the capacity for self-control, some of it genetic, some of it experiential (life experience, parental influence, etc.), but clearly some are endowed with more than others. Self-control is the personality trait most closely associated with academic achievement, career success and marital stability. For the retirement saver, a lack of self-control can lead to other behavioral impediments.
Procrastination
Closely associated with self-control, procrastination is the tendency to postpone unpleasant tasks. Instead of engaging in a goal-achieving activity, such as retirement planning, that involves complexity and may lead to frustration, people often opt for a stress-relieving activity, such as watching a favorite television program.
Herbert Simon, a Nobel Laureate, related procrastination to “cognitive laziness,” which is the attempt by individuals to avoid the hard work of thinking through a problem.
Inertia
Procrastination, in turn, produces a related psychological force known as inertia, which is the resistance to change. This resistance often is the consequence of what is known as “loss aversion,” This is the tendency of decision-makers to put more emphasis on what they could lose rather than how they might benefit.
A key finding of behavioral economics is that people weigh losses significantly more heavily than gains. Some estimates peg the ratio at 2:1. In other words, losses generate twice as much psychological pain as gains yield pleasure.
Loss aversion affects saving decisions because once households become used to a certain level of take-home pay, they tend to view reductions in that level as a “loss,” even when it is the result of increased savings.
Compounding the challenge, saving for retirement involves a difficult trade-off between current and future consumption. The evidence is clear that most individuals have a strong preference for the immediate rewards of spending today over the future payoff of enjoying an increased standard of living in retirement.
In the next article, we’ll offer some solutions to help improve the chances of securing a comfortable retirement.
John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit https://ift.tt/2FWgwQA article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.
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