"The majority of Americans—59% according to
a 2019 study by Charles Schwab—say
they live paycheck to paycheck, making saving money a challenge. But
beyond the that, there are lots of reasons why people don’t prioritize
planning for their future, even though they know they should. It’s here
where research in behavioral science can help" writes David Hoffeld.
"One of the primary reasons why we don’t make choices that set ourselves
up for a secure retirement is because of how our brains are wired. Each
of us has cognitive biases that lead us astray. Yet, by understanding
these biases, you can make sure that you do not fall under their
influence."
Bias #1: Temporal discounting
(aka time preference) is a tendency to give greater value to rewards received sooner compared to much larger rewards if one is willing to wait.We are willing to settle for a small reward today rather than wait for a much larger reward in the future. If you've heard about the "marshmallow test" of delayed gratification with preschoolers, you know what I mean. See:
https://www.thoughtco.com/the-marshmallow-test-4707284
Adults who cash out retirement savings when changing jobs suffer from
Bias #2: Loss aversion
Investors tend to prefer avoiding losses over achieving equivalent gains.
Suppose you decide to move your investments to “safe harbor” accounts
(think money markets and CDs) to avoid potential losses in a down
market. The longer you stay in these kinds of accounts, the more you
risk losing some of your purchasing power to inflation. How do you know when to reinvest in the market?
Bias #3: Recency bias
Recency bias occurs when an investor tends to weigh recent events more heavily than earlier events. They think the recent past will repeat itself in the near future so investors look at what investments did well in the recent past and move their money into those investments at peak prices. See:
The Callan Table for a visual example of how investment categories vary over the decades.
Confirmation bias occurs when we favor information that reinforces the
things we already believe. It’s a common phenomenon in how we choose our
news sources (think FOX vs. CNN), and it’s also common in investing.
Get the details:
https://www.fastcompany.com/90453952/the-science-behind-why-saving-for-retirement-is-hard
OK... now what can you do to address these threats to your financial security?
The Top 3 Blind Spots That Keep You from Building Wealth
"DALBAR’s Quantitative Analysis of Investor Behavior study tracks investor returns and
finds consistently
that the average investor earns much less than market indices suggest.
For example, according to DALBAR, the average investor lost 9.42% in
2018, compared to losses by the S&P 500 of only 4.38%. Why? DALBAR
attributed the loss to investor behavior — avoiding market volatility
by decreasing exposure, and even losing more money by being out of the
market during periods of gains."
"How to avoid recency bias: Look for context in
long-term trends, not just recent headlines, to provide perspective. If
you have worked with your adviser to create a financial plan, stick to
it. Jumping in and out of the market places you at greater risk. As
David Booth of Dimensional Fund Advisors puts it,
“Missing out on big growth has as much of an impact on a portfolio as
losing that amount. How long does it take to make that kind of loss
back? And how is someone who got out supposed to know when to get back
in?”
"How to avoid loss aversion: Focus on your long-term
goals instead of worrying about the day-to-day ups and downs of the
market. You’ll sleep better and portfolio will continue to grow over
time."
"How to avoid confirmation bias: Always consider
multiple viewpoints. If you work with an adviser, ask him or her to help
you evaluate investments by including the pros and cons of any
potential decision."
Temporal discounting
Adults who cash out retirement savings when changing jobs suffer from TD. Do a simple compound interest analysis of how much those dollars would grow if you left them invested until retirement. Teh results can be surprising.
