Posted by: drdata921 | December 6, 2013

When It Comes to Retirement Saving, Are You Your Own Worst Enemy (II)


In the last post I documented the woefully low retirement savings balances that the average retiree will have available. In this post I will suggest that part of this problem is based on the psychology of savings that works against us. While some believe that humans are rational beings that can be counted upon to look long-term, the reality is far from this. Let’s take a look.


Saving for retirement requires us to accept some short-term pain (giving up income each month) for long-term gain (a financially secure retirement). However, people are not very good at that. Psychologists know that human behavior is driven by the expectation of short-term rewards and that behaviors that lead to undesirable outcomes in the short-term are less likely to happen. The principles of operant conditioning are the most basic drivers of human behavior. Very simply:

• Behaviors that are associated with short-term positive rewards become more likely.

• Behaviors that are associated with short-term pain or punishment become less likely.

• Experiencing short-term pain for long-term gains make the behavior, saving in this case, less likely. It is embedded in the emotional part of the brain that drives much of human decision-making. Short-term sacrifice is a negative emotion. Behaviors that produce negative emotions become less likely because negative emotions are unpleasant.

Retirement saving goes against this principle. When you save for retirement, you are giving up short-term rewards for long-term needs. You may rationally tell yourself that it is important to save for retirement. However, the negative emotion associated with what you are giving up in the short-term pushes you to an avoidance or minimization of the short-term pain. That is why we see either no savings or amounts well below what people will need in retirement. Nearly a fifth of workers who have access to a 401k plan don’t participate and those who do save only 6.8% on average – much less than needed.

However, there is more to it than that. Human behavior is willful. In other words we act with the expectation that a specific desired outcome will result. In this case, if we save for retirement, we expect to produce a positive financial situation. However, what if you believe that the amount of money that you will need to produce a financially secure retirement is unattainable.

Some sources say that you need a million dollars to retire. Others push that to two million or more. So, what you come away with is the belief that even if you are willing to accept the short-term pain associated with saving, you may not attain your goal of a secure retirement. Accepting the short-term pain will not guarantee the long-term gain. Is there any question that this could keep a rational person from making the sacrifices for a long-term retirement benefit?

Also playing into this is the fear that if you make the short-term sacrifices you may easily lose that money because of stock market volatility. So, if the short-term behavior causes the pain, but the long-term gain is uncertain then savings behavior becomes less likely.

By the way, most of the advice about how much money you will need when you retire is useless. Income and needs vary substantially from individual-to-individual and many authors are just resorting to sensationalism to cause anxiety and build readership. Take what you read relative to these guidelines with a grain of salt. Better yet, do your own assessments.


Once you decide to save in a 401k plan, for example, you have to make choices about how the money will be invested. Many companies, with the best of intentions, provide a multitude of investment options, giving you a lot of choices. Herein lies the problem. Having a lot of choices sounds like an ideal, but it may not be the best thing?

Let’s say that you have navigated the steps to sign up for a 401k plan and must now select your investments. What do you do? Research conducted at Columbia University has shown that having a large number of investment options can actually work against 401k plan participation. In their research they found that for every 10 additional investment options, you see a 2% reduction in 401k plan participation. In other words, having more choices can drive people away from signing up. Simply put, they become overwhelmed and decide not to participate.

However, the problem doesn’t stop there. When you sign up for one of these plans, you must not only choose investment options, but you also must decide what portion of your savings goes into each of the options you select. One common mistake is to select let’s say five different investment funds and to allocate an equal percentage of your savings to each. Selecting more investment options is a way to hedge your bets based on risk and market performance. However, if you allocate your savings equally among the options, you may be over-allocating your savings to the worst performers and under-allocating your savings to the top performers. Again, information overload can take a toll on the quality of retirement investment decisions. So, even if you decide to save, you may not be optimizing your returns.


The psychology seems daunting. It is a small miracle that anyone decides to save given all that is working against it. So, how do you get around the psychological forces that could keep you from saving for a successful retirement? Here are a couple of research-based solutions:

Make the pain invisible: If you have to write a check each month to your retirement savings, the pain is apparent and very visible. You see it and you feel it. Researchers have found that the solution is to make the pain invisible by using automatic deductions so that the person never sees the money coming out. This seems to increase the number of people who participate and decrease the number of people who drop out.

Increase the contribution percentage invisibly: Put automatic changes into the system by making contribution increases automatic. If I start out saving 5% of my income to get the full employer match the first year, have this adjusted by some percentage each year until you hit a maximum. For example, have the saving rate increase by 2% each year until you hit some maximum such as 15%. This strategy seems to work because, again, the periodic changes are relatively invisible – you don’t feel the pain as directly.

Simplify the investment options: When it comes to investment options, fewer high quality choices are better than a large variety of options. It will simplify the situation and make sure savers are not overwhelmed. Of course, the operative term is “high quality” offerings which puts the onus on your employer.

So, there is a huge savings-related problem as people head for retirement. However, there are also some practical solutions. When it comes to retirement savings, don’t be like one author who quipped, “I’m now as free as the breeze – with roughly the same income.” You can make a financially successful retirement happen!


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