How You Can Hack Your Retirement Plan
Your future self will be thankful.
Bloomberg, July 8, 2019
The holiday weekend has come and gone. Did it meet expectations?
If not, it was a lost opportunity. Behavioral economics has given us numerous tools to hack our vacations. Indeed, we can use what we know of human psychology to improve our consumer spending as well.
Some of this has applications in how you manage your leisure time, as many of you just did over the Fourth of July holiday, or everyday consumer purchases. For that we can thank behavioral economics, a transformative science whose proponents — folks like Richard Thaler, Robert Shiller, and Danny Kahneman — have won Nobel prizes and changed how we think about decision-making.
But even more importantly, you can take these advances and apply them to your investments. I propose you take a look at how you and your employer and plan sponsors can hack your investing process.
There are so many psychological and behavioral aspects to investing, I am going to limit our discussion to retirement planning. Here’s how to start:
1. Visualize yourself as older: People who can see themselvesas older tend to save more for retirement. Even better than that, just imagine yourself with gray hair. Some researchers have used computers to generate images of individuals, showing how they will look decades from now. In multiple studies, participants who are shown realistic computer renderings of their future selves devoted more resources toward retirement savings.
Neuro-economists like Colin Camerer, professor of behavioral finance and economics at the California Institute of Technology, uses technologies to create immersive hyper-realistic imaging in order to help people “better imagine what various futures might be like.”
Once people see a life-like realism of their future, it leads to profound changes in how they allocate assets. They save and invest more, and generally change their behavior as if saving for retirement is actually important to them.
2. Plan-sponsor nudges: This one is more for employers — make changes in the default settings of corporate retirement plans to improve outcomes for workers. Consider these three simple change: Make enrollment automatic for all new employees at the company; deductions from wages are programmed into payroll, and workers must opt out if they wish to avoid saving. Second, set a qualified default investment alternative, typically a target-date mutual fund, which automatically invests the dollars rather than letting the cash pile up in a money-market account. Last, use an automatic step-up to raise employees’ plan contributions based on time with the company.
Better designed corporate retirement accounts go a long way to overcoming all manner of bad behavioral biases. You can thank Richard Thaler for making your nest egg that much bigger.
3. Put your plan in writing: I have discussed the value of having a financial plan before; let’s go one step beyond that to understand why you not only want a plan, but want your investment strategy to be in writing.
Robert Cialdini, professor emeritus of psychology and marketing at Arizona State University, has pointed out that people prefer to be consistent before making a commitment — and a written statement is a strong commitment. In his book, “Influence: The Psychology of Persuasion,” he notes, “Once we have made a choice or taken a stand, we will encounter personal and interpersonal pressures to behave consistently with that commitment.” Investors can take advantage of this desire for consistency to help guide their future behavior now.
4. Avoid the tyranny of too much choice: In his 2004 book “The Paradox of Choice,” Barry Schwartz notes that altough “modern Americans have more choice than any group of people ever has before, and thus, presumably, more freedom and autonomy, we don’t seem to be benefiting from it psychologically.” Every stock-picking investor knows this by its Wall Street nickname, “paralysis by analysis.”
The solution, which works as well for 401(k) retirement-saving plans as it does for refrigerators, is to keep the number of options limited. For those of us who help create 401(k) plans for employers, it means not overwhelming participants with too many options. What works well are several distinct choices: Target-date funds, designed to shift asset allocation the closer the beneficiary gets to retirement; several broad index funds based on the U.S. stock market, developed markets excluding the U.S.; emerging markets and bond funds. And then a handful of choices for the do-it-yourselfer. But it should not supply so many choices as to overwhelm the participant.
5. Anticipate the shift from accumulation to distribution: One of the hardest things investors have to do is mentally make the shift from working and saving to retirement and spending. It’s the reversal of a lifetime of good economic habits.
Too many people in retirement who have substantial savings are fearful of running out of money. With longevity for many people increasing, it’s a real concern. Use software or a financial adviser to create a plan that will calculate your lifetime needs and future spending requirements. Figure out exactly what is leftover, and don’t be afraid to spend it. Use your excess to travel, donate to charity, give money to grandkids, whatever brings you satisfaction.
That is the beauty of behavioral finance: using what we have learned to improve decision-making. Don’t wait until the next Fourth of July to get started.
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I originally published this at Bloomberg, July 8, 2019. All of my Bloomberg columns can be found here and here.
