Our deficits are many, and they’re not entirely our fault. We’re the products of ancestry, culture, and upbringing, after all, and we approach retirement planning with deep-seated forces stacked against us that go back to humanity’s earliest days.
“There are good, biological reasons why you want to live with what you have rather than save for an uncertain future,” said Jeffrey Stevens, assistant professor in the department of psychology at the University of Nebraska-Lincoln, who studies the development of human decision-making.
Read: We’re all idiots about money and there’s little we can do about it One byproduct of this evolutionary, cultural and parental baggage is an estimated national retirement deficit — the amount by which U.S. households will collectively fall short of their projected needs — of $4.13 trillion, according to the Employee Benefit Research Institute. And while average 401(k) balances at Fidelity hit a record last year, that average was just enough to fund one year in a private room of a median-cost nursing home.
D MA MB MC MD ME ZG ZH ZQ ZR ZS ZT ZU To close that gap, retirement plan designers are taking aim at human behaviors in both plan design and employee education to encourage better saving. This isn’t altruism: Well-designed retirement plans can help employers attract and retain workers, and companies generally prefer that their workers retire on schedule to manage costs.
They’re doing that by plumbing the field of behavioral finance, which studies the reasons people make seemingly irrational financial decisions. MarketWatch explored three of the biases — default, present and optimism — that may be keeping us from saving as much as we should without our realizing it.
Default bias pulls us toward the option in front of our faces
It’s natural that humans feel comfortable sticking with the default. Hunters and gatherers didn’t accumulate wealth for the future, instead consuming resources as they became available, said Coren Apicella, assistant professor of psychology at the University of Pennsylvania. While daily survival was no mean feat, it didn’t require much complex decision-making.
Our default bias might be an outgrowth of “a mismatch between our ancestral environment and the modern world,” Apicella said. Humans today need to make complex, forward-looking decisions that weren’t required of us in our ancestral pasts. Whenever possible, we let those decisions slide.
Students of human behavior have long known that we eschew active decision-making, preferring to stick with whatever option is before us. The Pension Protection Act of 2006 paved the way for the widespread use of auto-enrollment, which exploits inertia by enrolling workers in 401(k) plans automatically and requiring those who don’t want to participate to opt out.
Read: 7 lies investors tell themselves
Similarly, auto-escalation automatically increases the rate at which employees save. This is key, since around half all of plans still default participants into a too-low savings rate of 3% of their salary — a rate workers tend to interpret as a recommendation rather than a fluke of history. (The 3% rate became widely adopted after it was used in an early government illustration that wasn’t intended as an endorsement, industry experts say.)
Since we’re hard-wired for passivity, companies are studying the best times to let workers know when to act. “If you’re asking people to make complex decisions, it matters if they’re not tired,” said Stephen Wendel, head of behavioral science at Morningstar. A study Wendel’s team conducted for a large retailer found Sunday evening was the best time to email employees, while a large manufacturer found the sweet spot during a midweek morning.
And then there are times to avoid: “At 2 a.m. you don’t want to send anything, because half of the people on the Internet are drunk,” said Shlomo Benartzi, professor and co-chair of the behavioral decision-making group at the UCLA Anderson School of Management and chief behavioral economist at AllianzGI, who has studied how plan participants make decisions. (One finding: “People make more emotional decisions on smaller screens.”)
We can co-opt our default bias for our own good with some self-awareness, said Sudeep Bhatia, assistant professor of psychology at the University of Pennsylvania. Those with college-bound children, for example, can put college savings on autopilot through regular bank account withdrawals into a 529 plan.
Present bias makes the pull of instant gratification strong
Instant gratification is well-documented in scientific literature and ingrained in our consumer culture. Humans tend to prefer current rewards over future rewards, discounting the gains that frugality today can yield tomorrow.
“Universally, people are motivated for the here and now,” said Hal Hershfield, assistant professor of marketing at the UCLA Anderson School of Management, who has worked with Prudential on various campaigns that use behavioral finance to help people save.
From an evolutionary perspective, this makes sense: The future was uncertain for ancestors who spent their days hunting wild animals. What’s more, saving for the future might have meant starving now. (That remains the case for many low-wage workers today.)
Our upbringings can either enhance our natural tendency for instant gratification or help us restrain it. People who grew up in households where money was regularly discussed but not argued about usually have better impulse control than those who grew up in homes where discussing money was taboo, said Nancy Molitor, a practicing clinical psychologist and assistant professor of clinical psychiatry and behavioral sciences at Northwestern University Feinberg School of Medicine.
Read: 6 ways thinking differently can make you money
Molitor has affluent clients who never had to limit purchases growing up. Their parents bought them whatever they wanted, and the means to that end wasn't discussed. This makes it hard for them to self-regulate in adulthood. “I often see people with the means to save, in their prime earning years, and yet they struggle,” Molitor said.
Saving seems risky to these people, Molitor said, even though not saving is far riskier. Gradual exposure is key in helping them overcome their fear, she said. Beginning savers can start by putting away a tiny amount a month — as little as $1 will do — and then gradually increasing that amount when they see that no harm has come from their efforts.
Regardless of our backgrounds, it’s hard for most of us to envision our future. This makes saving for a vague point on the horizon more difficult than saving for, say, a wedding next year. This, too, has evolutionary underpinnings.
Courtesy Prudential A photo of this story's author, aged using an application like one Prudential provided to a client. (Courtesy Prudential) D MA MB MC MD ME ZQ ZR ZS ZT ZU When the human race began more complex thinking thousands of years ago, the average lifespan was much shorter than it is today. “We didn’t live that long,” Stevens said. “There was minimal retirement.”
Prudential and other companies have tried to help workers over this hump by aging pictures of their faces. “It’s trying to ramp up the emotional connection to our future selves,” Hershfield said.
To the extent that we can visualize our futures, we might picture them differently than our peers. Companies have begun tailoring the retirement images they present to particular worker demographics, said Robyn Credico, defined contribution practice leader at consulting company Towers Watson: While a lone figure on a golf course might be the ideal retirement vision for some, others might prefer a picture of a large, multigenerational meal.
Those of us without full-on phobias who nonetheless find it hard to save can make indulging harder, experts advise. We can avoid the shoe store if we can’t leave without buying a pair, delete the bookmarks of our favorite online retailers, stop saving our credit card information on e-commerce sites and opt out of promotional emails.
Optimism bias can make us think too highly of the days to come
People tend to be optimistic about the future, which causes us to rationalize our lack of planning. “Things will work themselves out,” we say. Or, “I’ll deal with it when I get there.”
This could have evolutionary underpinnings, according to Stevens. If our ancestors weren’t optimistic about the future, they wouldn’t have ventured forth to explore new lands, and society wouldn’t have progressed to the extent it did.
When motivating employees to save for the future, Fidelity opts for positive reinforcement instead of negative messages that can foster apathy, said Jane Souza, senior vice president of workplace solutions at Fidelity Investments, which acts as the 401(k) record keeper for 21,000 companies representing 13 million investors. Instead of a red “danger zone” on the online dashboard of a saver who’s not on track to meet her goals, for example, the system may give her a green check mark when she completes a step to encourage her to continue.
Prudential has designed employee seminars to address optimism bias, part of the company’s effort to “blow up” traditional 401(k) education, said Jennifer Putney, vice president, marketing & strategy, total retirement solutions at Prudential Retirement.
Workers are asked to post experiences that happened in their past on one board, and post experiences that might happen in their future on another board. Good things went on yellow post-its and bad things went on blue post-its. (The company also ran a television commercial showing this exercise done on a large scale with magnets.)
The board representing the past was an even mix of yellow and blue, but the future board was mostly yellow. The goal is for workers to realize that the future, like the past, will probably be a mixed bag , and that it’s prudent to set aside funds for the rainy days to come.
Simply recognizing that optimism bias exists can go a long way in helping us overcome it. Part of that involves recognizing that we’re not going to magically become different people as we age.
“We’ll have the same emotional makeup in the future,” Hershfield said. If we can easily save today, we’ll easily save tomorrow. If it’s hard for us to save now, it will require effort — and not the passage of time — to change that.
Culled from MarketWatch
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