Consider the following choices:
1) You are offered a snack to eat now – would you prefer a chocolate bar or an orange?
2) You are offered a snack now to eat next week – would you prefer a chocolate bar or an orange?
People predominantly choose the tasty but unhealthy snack for immediate consumption, but pick the healthy snack for the future. However, once that future date arrives, if given the option to switch, they again go for the high-sugar high-fat chocolate bar.
This example highlights one of the main behavioral challenges in saving for retirement: as humans, not only do we tend to overweight our experiences today at the expense of those in our future, veering towards instant gratification, but we also change our preferences over time. In effect, we make choices today that our future selves would prefer not to be making, whether it’s to eat healthier or quit smoking. This is known as the present bias. In today’s post, I’ll take a look at this phenomenon – and several others – that investors often face when saving and investing for retirement.
What are some common saving and investing behavioral derailers?
In addition to present bias, behavioral mistakes in saving and investing for retirement include:
- A lack of discipline to take the actions we know would be right for the longer term.
- Procrastination and a preference for the current state of affairs, also known as the status quo bias. This can arise for a variety of rational and behavioral reasons including lack of motivation, greater sensitivity to losses than gains (loss aversion), and the fear of potentially making a wrong decision.
- Rules of thumb such as anchoring, an over-reliance on the first piece of information offered, and naïve diversification rules.
- Overconfidence and other biases that have been found to plague individual investors’ portfolios in general.
What are the financial implications of behavioral biases?
The above behavioral biases can meaningfully impact the ability to meet one’s financial retirement goals