Behaviors that can create roadblocks to smart financial choicesFinances
We should all have a plan to make sure we're financially prepared for a long, healthy, happy retirement. But we often give little thought to retirement planning. Many times we think of it as a challenging process — especially when there are many factors to consider. "How much money do I need to retire?" "What will my spending habits look like?" "How do I ensure my money will last as long as I do?" These concerns are certainly understandable, but could there be other reasons?
To find out why Americans don't always act in their best interests when planning for retirement, Athene commissioned a review of research by experts on consumer investment behavior from the UCLA Anderson School of Management. According to the research, many of us have biases that create roadblocks to investing — biases many of us don't even realize we have. Here are four common biases to be aware of as you plan and dream for your ideal retirement. Once you know these behavioral tendencies exist, you'll be on the path toward making smarter financial decisions:
We favor the simple solution.
When participants in a research study were asked to choose between two life-cycle funds with different levels of risk — one described in easy-to-understand language, the other in complex terms — the results were striking. The simply described funds were the preferred choice, regardless of the risk factor.1
We're unrealistically optimistic.
Research shows that most people think they're better-than-average drivers.2 Of course, not everyone can be above average! Optimism is great, but too much can cloud your judgment, especially regarding planning your financial future. People often underestimate the chance of bad things happening to them, such as major health care costs or losing a spouse.
We base decisions on recent and highly publicized events.
When asked which is deadlier, a shark or a cow, many people say shark. While shark attacks get more headlines, five times as many people are killed each year by cows than by sharks. People generally focus on top-of-mind events — whether that means a shark attack or a hot stock market. So they often base investment decisions on recent market performance, even though the recent past may not be a good indicator of the future.
We choose immediate gratification over future preparedness.
Given the choice between $500 today or $1,000 in five years, research shows many people would take the $500.3 The desire for immediate gratification can lead people to avoid sacrifices that could pay larger dividends in the future. For example, they may save less for retirement to hold on to more of their paychecks, even if it means forgoing free money offered by their employer from a 401(k) match.
1. Hadar, L., Sood, S. & Fox, C. R. Subjective Knowledge in Consumer Financial Decisions. J. Mark. Res. 50, 303–316 (2013).
2. Weinstein, N. D. Optimistic biases about personal risks. Science (1980). 246, 1232–1234 (1989).
3. Kirby, K. N. & Marakovic, N. N. Delay-discounting probabilistic rewards: Rates decrease as amounts increase. Psychon. Bull. Rev. 3, 100–104 (1996).