Saving for retirement is not a priority for many Americans. Current financial opportunities often take precedence and result in delaying or reducing the amount people save for the future. With the average monthly Social Security benefit at $1,335 or $16,020 per year, people need their retirement savings to make up the difference between Social Security and their desired income level. According to Fidelity, sixty-year-olds should have at least eight times their annual salary in savings in order to prepare for a comfortable retirement.
Clearly, the path to retirement is a journey, resulting from an accumulation of choices over many years. Unfortunately along the way, people encounter a myriad of opportunities and challenges that can take them off the path.
According to behavioral economists, saving for retirement is considered cognitively difficult. It requires people to determine how much to save and then have the self-control to follow through to achieve it. Traditional economic reasoning assumes that people are able to make these determinations and do what it takes to make it a reality. Of course, that isn’t necessarily the case. In a recent report from BlackRock, the average Baby Boomer wants to accumulate a nest egg that can support $45,500 a year in retirement income. However, the average retirement portfolio is about $136,000, only enough for an estimated income of $5,440, leaving most people more than $40,000 short of their annual goal.
So, why can’t we save?
Behavioral economics can help us understand what factors influence our behavior. Here are a few examples:
- Anchoring: If asked to repeat silk five times and then asked what a cow drinks, many respond with milk, but cows drink water. This priming effect occurs when exposure to something influences your subsequent judgments.
- Loss Aversion: The pain of losing is psychologically nearly twice as powerful as the pleasure of gaining. This leads people to become unwilling to sell an asset at a price less than they paid for it. People will often hold on to an asset, such as property or stocks, even if further depreciation seems likely, just for the chance of getting their money back.
- IKEA Effect: This effect occurs when a person’s invested labor leads to an unrealistic perception of the value of a product or service. It can distort a person’s value of items, such as their home or property, because they’ve put time and effort into it.
- Path of Least Resistance: People often find that the easiest thing to do is nothing, a phenomenon called passive decision-making.
- Availability Heuristic: People make judgments about the likelihood of an event based on how easily an example comes to mind. For instance, investors may judge the quality of an investment based on information that was recently in the news, ignoring other relevant facts.
These factors cloud our ability to take the necessary steps to ensure a secure financial future. Further, people find it difficult to visualize themselves in the future, so they place a higher value on the short-term than in the unknown longer term. To change these patterns, it’s important to create a connection between the current and future, and remove these influences in order to make objective choices for a more secure and comfortable retirement.
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