What if I told you clients don’t always make retirement decisions that are in their best interest? What if I shared that I could explain why some clients thrive while other clients struggle with their new life in retirement? Or what if I suggested that our industry’s overreliance on financial factors to make retirement decisions is a major reason why a growing number of people are failing at it?
Then you would understand the role behavioral economics can play in retirement decision making. Like behavioral finance, the field of behavioral economics combines insights from psychology, judgment, decision making and economics to generate a more accurate understanding of human behavior. This is important because it brings a more personal element to the retirement decision-making process, rather than just another portrait of dollars and cents.
If you search behavioral economics, you will come across a litany of articles and stories about it and retirement planning. The only issue is that all of these articles pertain to the financial aspects. This article takes a completely different stance and frames these concepts in terms of non-financial situations.
This is important because one of the hallmarks of behavioral economics is the belief that people make better decisions when they have the right information, at the right time, and with the opportunity to receive prompt feedback. Therefore, when advisors assure clients that they can retire and stay retired based on savings and their financial projections, they are not giving the client all the information they need to make an informed decision about this next stage of life. As a result, they are setting clients up to stumble, if not completely fall flat on their face during the transition.
I can’t emphasize how important this is and want to use the science to show you. Behavioral economics suggests that there are two types of decisions that we make: system 1, or automatic decisions and system 2, or reflective decisions. System 1 decisions are very intuitive and commonly associated with a gut feeling. When someone throws a ball at you and you duck, that’s a system 1 response. It’s instinctual, meaning you don’t have to think about it.
System 2 decisions are more reflective. If I were to ask you to multiply 250 x 311, you would have to stop and think it through—picturing the problem and following a set of rules or guides to go through it. Reflective decisions take more time and effort.
This is interesting because when it comes to traditional retirement planning, I think many advisors and clients would agree that it is a system 2, reflective decision. It has a lot of moving parts to think through and consider. So, advisors and clients spend a lot of time going over a variety of scenarios and options in an effort to help the client feel confident about their decision to leave the workplace.
But here’s the issue, and it’s a big one. Not all retirement decisions fall into a reflective, system 2 decision category. The non-financial parts including things like replacing a work identity, filling time, and staying mentally and physically active tend to fall into system 1 decisions. People assume the personal aspects of life will automatically fall into place if they have enough money, the right asset allocation and are an age associated with retirement.
But nothing could be further from the truth and highlights exactly why people not only fail at retirement, but also struggle to figure out where they went wrong. Think about where a client is coming from. They know retirement was on the horizon and so they were meticulous in their planning—double and even triple checking their numbers, the charts and graphs. They spent a lot of time and energy to get this right, but now that they are there, why does it feel so wrong or out-of-sorts?
The answer is simple. They did not apply a reflective approach to the non-financial aspects, which drives a much larger portion of their life in retirement. I see this all the time. Clients are lost, confused and can’t figure out why. Which is why we need to take what science, and client interactions, are telling us, and develop a more comprehensive pre-retirement process where clients can get all the information and resources they need, and not waste the first few years wondering what happened.
The applications of behavioral economics don’t end with the initial decision-making process. Another issue and opportunity is tied to the concept of anchoring. Anchoring is when you use existing information to construct a figure or other answer. A popular example in the literature suggests that if you had to estimate the population of Chicago, you would take information you already had, like the size of your city, and apply those figures to gauge the size of Chicago.
On the retirement front, there are two primary anchors that tend to drive retirement decision-making behavior that advisors and clients need to be aware of, and that we have to begin to change: age and assets. While I can only provide empirical evidence, if you were to ask a group of people, “How much money they need to retire?” the most popular (system 1) response would be, “A million dollars.” Additionally, if you were to poll the same group, asking them for the most common age in which people retire, you would hear ages 62-65.
As you might expect, people use this information to establish retirement dates and plans. However, in addition to this, they also use that information to judge and stereotype others. For example, take the person age 67 who is still working. While, he or she may enjoy their wok and have found a balance between it and their home life, age and asset anchors can suggest a different conclusion. Implying that the 67-year-old doesn’t have enough money saved to retire, doesn’t want to spend time with their spouse or family, or both. As a result, the currently accepted retirement age is causing social issues including ageism.
This need to address issues associated with the standard retirement age allows us to look at another aspect of the non-financial part of retirement that doesn’t get enough attention. I call it the “status quo of home life.” What I love about behavioral economics is the assumption that people are flawed, can make impulsive decisions that don’t always support their long-term goals, and that they prefer to make simple decisions rather than complex ones. In other words, people go with whatever is easiest. They don’t want to break the status quo. In other words, they select the default option.
Think about it this way, when you get a new phone or laptop and go in to set it up, do you go through all of the advanced features or accept the default setting and get on with your life? Most people accept the default setting and make adjustments later. The same thing happens to people when they retire. They just do what is easy and what they already know.
This is such a crucial point that gets missed by so many professionals. To put it simply, retirement makes people more of what they already are. It doesn’t change them or make things better. In its most basic form, it gives them more time to do what they want, which is usually what they already know.
This idea of a default or status quo life is one reason why I cringe every time an advisor says, “You have to retire to something.” Nothing could be further from the truth because you’re giving clients permission to follow their current path and then change course once they leave work. Harsh reality is that retirement doesn’t come with extra energy or motivation, so even those with the best intentions to eat better, exercise more often, spend more time with family or travel rarely follow through. Instead they default to what they know. Hence, the reason why so many wives stereotypically say, “All my husband does is sit on the couch and watch TV.”
A final and crucial application of behavioral economics to retirement has to do with loss aversion. Many advisors understand that clients don’t like to lose money, which is a big reason why annuities sales seem to increase year over year. Some clients don’t ever want to feel like they did in March of 2009. So, they opt for a product designed to eliminate the downside risk (bad feelings) even if it means giving up some of the upside. This fear of loss plays a significant role in how people invest and allocate their money.
The same doesn’t hold true for the more personal side of retirement. When a client goes to retire, you never hear their employer or advisor say, “If you stop working, you could end up feeling really bad, alone, irrelevant and even depressed because you have lost your social life here, your purpose, identity and even the physical activity of walking in and out of work every day.” Instead, retirement is framed as this never-ending positive scenario where more freedom and less stress will cross out any potential losses from it.
Since retirement has been portrayed like this for years, by both the media and from their local professionals, people assume it to be true. This in turn causes many people to make a system 1 decision with the non-financial aspects of retirement, thus setting them up to fail from the get-go. It’s a maladaptive, or negative cycle that perpetuates a series of ongoing problems within the retirement decision-making process that we need to change.
Overall, these factors and scenarios highlight the importance of incorporating the latest research and science into both the financial and non-financial aspects of the retirement decision-making process.
Robert Laura is the president of SYNERGOS Financial Group, the founder of RetirementProject.org and pioneer in Certified Retirement Coach training. He can be reached at [email protected].