More thoughts on retirement planning

An article posted by CNBC.com—Bust of the Baby Boomer Economy: ‘Generation Spend’ Tightens Belt—proposes a gloomy economic future due to Boomer ageing.

Jessica Rao, the article’s author, argues “because of severe recession and stock market losses, Boomers have less to spend, and further, they’re entering a post-career life stage when they will reduce spending anyway.”

While this story may be accurate in aggregate—overall national economic growth may decline from loftier times 15 years ago, due to many factors including global competition.  But first, we have to worry about getting enough money to retire.

We are not rational, autonomous, micro calculators who exercise independent and unbiased judgment when it comes to our retirement plans. Most of us strive to maximise our self-interest, but for a variety of reasons we often fail to act in accordance with the expectations of rational economic and financial theory.

Some of us have self-control problems when it comes to saving;. Others of us simply over discount the future and overvalue the present; we could benefit from pre-commitment pension savings programs. Still others of us may be unduly influenced by our ability to make or not decisions and as a result, our attitudes and action diverge so very much; we want to save more for retirement, but we do not.  Also, some individuals only evaluate their investment portfolios by past performance and risk errors cloud their judgment. 

We are overconfident about the future and have trouble cutting our losses. There are some of us who do not know what the basic questions are,  we do not know how much to save, or how much risk to take. Before the government takes steps to change what we understand about retirement planning there should be plans in place to help those of us who are rational economic agents. We could benefit from commitment devices or from education.

The problem is that contemporary education practices assume that most of us are rational agents and planners, but the evidence suggests that large numbers of us simply are not. Mechanisms must be found, whether through how plans are developed or to delegation to a third party, where workers begin practising the right behaviours when they start to work. 

Education can play an ancillary role, explaining the rationale for the way the plans were developed and alternative courses of future action. In effect, there should be a shift from education driving behavioural change to initial behavioural change preceding education.

More thoughts on planning for retirement

Why do investors irrationally rely on past performance and fail to take expected returns as well as risk into account, as modern portfolio theory suggests they should? Two behavioral phenomena may offer some answers. The first reason may be that people tend to see patterns in small series of randomly drawn numbers, and when making decisions, people attempt to impose some order or structure on the information that they see. The second reason may be that many people when faced with difficult decisions tend to rely on readily available information. A simple reason that investors may rely on past performance could be because that information is cheaply available.

The following ideas may help us understand how we make the investment decision we make. First, when we are thinking about how much we will gain, many of us are often overconfident and filled with excessive optimism.

We tend to, in our minds, build forecasts of the future that are typically too rosy. Second, when we are considering how much we could lose, risk-aversion may lead some of us to over react to what we are actually losing in our investments or because of fear of a loss, we will take investment gains earlier than we should. And third, if our decisions are less than ideal due to both overconfidence and loss avoidance, the impact of these will be exacerbated by how we have framed the issue and we tend to have narrow frames around gaining or losing money.

One of the important findings of psychology is that peoples’ future forecasts are often characterized by widespread overconfidence and excessive optimism. Such overconfidence may partly be the result of an inability to understand accurately the role of random chance in determining the future. People are notoriously poor statisticians, and they find patterns and trends in data that could just as easily be explained by random chance.

Poor risk calculations certainly play a role in overconfidence: individuals who are “100% sure” of their responses to certain questions are usually wrong 20% of the time. Our perceived sense of control also plays a role: the stronger one’s sense of control, the more powerful one’s sense of confidence

If overconfidence helps explain behavior on the “upside” then the “downside” is dominated by aversion to loss realization. This may play  out in interesting ways. For instance, as people are inclined to take a gamble if confronted with the choice of realizing an incurred but not-yet-realized loss, versus taking the gamble in which they might break or lose more. If there is a reasonable prospect of breaking even and avoiding a loss, many people take the gamble and risk losing even more money

There is evidence that overconfidence and loss-aversion are intensified by too narrow a framing of risky decisions. Few of us would take a gamble involving a 50 percent chance of winning $1,500, versus a 50 percent chance of losing $1,000.  

Some studies suggest that losses are as much as twice as psychologically powerful as gains. Other studies indicate that losses are almost three times more powerful than gains. What this means is that most of us would not take the gamble until the gain was closer to $2,500. Yet experimental evidence indicates that if we are given the opportunity to accept this gamble many times, or when it is framed in terms of changes to their entire net worth we will take the gamble.

Perhaps it is more natural for us to think small when facing a one-time gamble, but because we think we may get it right over time then we think large and take the gamble.

The last phase of financial decision making for retirement happens during later middle-age and beyond, and it is the period when most people decide how they will spend down their accumulated assets. Because most of us do not know precisely how long we will live, we do not want to run the risk of exhausting our assets before dying.

We can do this by reducing what we consuming less per year during retirement, but of course this simply elevates the chances that a we might die with “too much” wealth left over. This is fine if we want to leave our wealth to our heirs, but a few years back I saw many bumper stickers that say “I am spending my children’s inheritance”, which I agree with for the most part, but today those bumper stickers are few and far between

 Interestingly a recent survey reported that only one-third of the respondents knew that if someone who attained the age of 65 they had a substantial chance of living beyond his/her life expectancy.

More thoughts on planning for retirement

I was talking to my accountant about planning for retirement and he mentioned that there is one thing that young people and my people age do not plan for. He mentioned that people including sonic boomers have roughly $3,000 to $6,000 in medical bills not covered by any plan. He also said that many of his clients who are living on just Old Age Security and the supplement are sitting on homes that are paid for, and if sold would help the person have a better quality of life. He said that when he mentions this his clients respond with this sentiment: I would love that but if I do, what would I leave my children?" 


So poor planning and misguided sentiment (in my mind) leave people living in poverty or near poverty. I am sure that people understand the need to save, I am not sure why they don't save. That is why I found the ideas expressed by Olivia and Stephan interesting, I hope you do as well.


What might explain this apparent inability to plan properly for retirement? People try to save for retirement, but they too often not able to execute intentions. In a sense, saving for retirement requires behavior similar to those undertaken in other behavior modification programs such as exercising, dieting, quitting smoking, or following through on New Year’s resolutions. In other words, a key obstacle to saving more is not necessarily lack of awareness, but rather the ability to take action on the knowledge.  Here are some reasons why this happens.

People understand their inability to act even when they have good intentions and often seek to protect themselves through the use of commitment devices, or mechanisms that help foster desirable changes in behavior.

“Pay yourself first” is one of a number of standard commitment device used by financial planners and others who want to encourage disciplined saving and budgeting. Other commitment devices include tax refunds and Christmas or other Clubs, where individuals engage in economic activity that on the face of it are not economically sound (e.g. loaning money to the government or to their local banks at below-market rates). What the individual gets in exchange is a disciplined approach for accumulating savings. Another commitment device that is used by the government is to impose high penalties and withdrawal restrictions on retirement plans. The idea is that once the money is allocated to these plans, a psychological and financial hurdle is imposed on the individual accessing the money, which will help to counteract lapses in personal willpower.

People can be easily influenced by decision framing. In traditional economic theory it is assumed that rational economic agents (individuals) would not be expected to vary their responses to a question based on how it is asked. We know this is not the case. The simple rephrasing of the saving question elicits a different response in plan participation rates. Researchers have shown that when workers whenA faced with the option that requires them to sign up for a savings plan then they do nothing. If the employer institutes an automatic enrollment plan (that you can opt out of at any time) with a saving rate specified by the employer or the union more people save at the rate specified by the employer. This behaviour is explained by the idea that when confronted with difficult decisions, individuals tend to adopt shortcuts that simplify the complex problems they face. One simple shortcut is to accept the available default option—i.e., rather than making an active choice, accept the choice made by others. For one large US firm, plan participation rates jumped from 37 percent to 86 percent for new hires after automatic enrollment was introduced.

Evidence reveals another anomaly about individuals and their saving behavior: the important impact that inertia or procrastination plays on decision-making.  Researchers have concluded that, many of us follow “the path of least resistance” in our decision-making. We make the easiest, rather than the best, decision. This passive approach to decision-making is indicative of individuals being somewhat imperfect rational economic agents in their retirement and savings decisions, especially when there is a great amount of choice.

Offering workers many investment choices can produce choice overload; faced with complex investment choices, some participants may elect to simplify the decision by following their default plan, i.e., don’t decide, don’t join the plan, or find out what friends at work are doing. Many of our saving decisions can be strongly influenced by peers.

Just as our saving choices can be affected by framing, so too can our investment decisions be influenced, sometimes strongly, by framing effects.

Silence is not an option