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.