March 18, 2014

Why aren't we saving enough for our old age?

I've quoted from "Retirement Roadblocks." You can read the full article at the link below.
"Three ways behavioral finance experts are trying to reroute our cerebral circuits to do the right thing."
"Economists, journalists, and financial-services companies love to pile on the subject of why most Americans aren't saving enough for retirement. But aside from the issue of not having enough disposable income to save, what if retirement saving is a behavioral issue?"
"We can do all sorts of mental backflips to avoid saving money. Can we reroute our cerebral circuits to do the right thing? Many specialists in the area of behavioral economics think so, and their research and discoveries are pointing the way to a more secure retirement. One of the main problems is that most people can't emotionally frame the idea of living for decades past retirement age, nor can they project (without the use of calculators) how much they need to sustain their lifestyle."
"In many cases, there are behavioral obstacles to saving, although they can be overcome.
Going Automatic
There are myriad reasons to delay saving. Many people will want to spend the money now while they have it. Others may be too deep in debt, while some may not have enough disposable income. There are always behavioral barriers to saving."
It's simple: sign up for automatic saving through work or on your own with an IRA.
Pre-Selected Portfolios
"Another bugaboo in retirement savings is the sheer complexity of creating a portfolio--particularly in 401(k)-type plans. How much do you put into a stock fund? What kind of stock fund should you choose? How do you properly diversify?"
It's simple: choose the target retirement date fund.
Identifying Biases
"The most pernicious emotional stumbling block, however, is our aversion to loss. Profiled by psychologists Amos Tverksy and Daniel Kahneman, their "prospect theory" posits that people go out of their way to avoid a loss. Kahneman later won the Nobel Prize in economics for his part in this research.
In this framework, contributing to a retirement plan today is viewed as giving up something--we'd rather spend that money now while we have it.
One of the best ways to overcome loss aversion is to "reframe" it as a gain. Money saved now will be worth more in the future. It's not a loss; it's a step ahead.
Financial planner Michael Kitces says that another reframing exercise is to project current savings as increased future spending.
"The concept is rather straightforward," Kitces writes. "Just commit to saving most of next year's raise, instead of cutting your spending now--yet the simple elegance is backed by a number of important behavioral finance concepts, including aversion to a loss of current lifestyle and taking advantage of our tendency towards hyperbolic discounting to make (future) saving less painful."
Another way to reroute anxiety over setting aside money from a paycheck is to see how much it can compound over time. Try Morningstar's calculator here"

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