Elizabeth Dunn and Michael Norton are co-authors of “Happy Money: The Science of Smarter Spending” (Simon & Schuster) and professors at the University of British Columbia and Harvard Business School,...
I’d like to write about the implications of living longer for retirement planning and the role that behavioral biases play in the difficulty people have in planning for their retirement years. My research interests are in how people think about the future, especially when they are planning for the future, and how thinking about the future is different than thinking about the present. My research supports what the physicist Niels Bohr (and many others) reportedly said, “predictions are difficult, especially about the future”. The first and biggest challenge is paying attention to the future long enough to make a plan. Why is thinking about the (far) future so difficult, especially when it comes to money? You might think it is simply because people are short-sighted and greedy. We know from behavioral research, however, that given a choice between a healthy snack and a sweet treat, people will eat the treat now and plan to have the healthy snack next week1.
However, when next week arrives, they do the same thing—indulging their current self now and promising virtuous choices for the future self. And to some extent, we see the same thing with financial behavior—people run up credit card debt to pay for a new TV or a winter vacation. But while I believe that self-control problems and what behavioral economists call “present-biased preferences2 ” are real and important, I think they are probably a relatively minor cause of the difficulty most of us having in thinking about long-term financial planning. I think it is important that people stop beating themselves up over their weakness of will and lack of self-control and realize that long-term planning is actually an unnatural act that requires outsmarting the brain’s natural focus on the present and near-future.
Rather than demonizing weak wills and poor self-control, I will point my finger at “temporal construal” and “loss aversion” as the 300-pound gorillas of behavioral biases that make it so hard to make good decisions about our lives in 20-50 years. These aspects of human psychology are simply part of the thinking machinery, the way the mind works. They are not signs of stupidity or greediness or weakness of will. “Temporal construal,” refers to the tendency for far-off events to be mentally experienced differently than closer events. In this model, “farness” and “nearness” can refer to time or distance3.
Events or ideas far off in time are thought of in abstract and general terms, with an unavoidable overlay of optimism; so thinking about yourself (or your children) in 40 or 50 years creates a mental image that is akin to pondering a vague, general, overly rosy idea rather than a detailed individual with real problems. Just think about the concept of retirement planning—one year in the future, 10 years in the future, or 30 years in the future—and I bet you can “see” this yourself. Thinking about yourself (or your children) today or in a few years’ time creates a mental image that is much more detailed, concrete and down to earth, more vivid, generally more realistic, and more focused on the specific, detailed problems that need to be solved. In other words, problems that exist in the short term will receive much more attention and generate much more motivation to solve those problems than problems in the long term, even if the problems are equally important.
How do we get over this? How do we “de-bias” people to think about their future selves more concretely and vividly? A quick answer is that we need to imagine our future self just as concretely and vividly, and take the time to imagine in detail the problems that our future self will encounter. In other words, we need to force ourselves to plan for that far off future in detail. Recent research in Behavioral Economics has shown that encountering one’s own aged face and pondering a vivid, concrete representation of the self in the far future can indeed shift saving intentions, at least in experimental settings.
“I think it is important that people stop beating themselves up over their weakness of will and lack of self-control and realize that long-term planning is actually an unnatural act that requires outsmarting the brain’s natural focus on the present and near-future.”
The next challenge is what behavioral economists call “loss aversion”, first noted by the mantra “losses loom larger than gains4 .” Now think of what looms large for workers in their thirties and forties. Is it the gains from their current salaries, or the gains that they could put aside for retirement forty years down the line? No, what looms large, so large that it dominates their thoughts about their financial hopes and dreams, is the hope of reducing their debts and the fears of being crushed under their debts. Where do these debts come from? Not from self-indulgence but from perfectly rational and socially approved investments in the future. Increasingly, they represent student loan debt. But more traditionally, and on a larger scale, these investments represent housing debt, and mortgage debt in particular. My point is that these traditional investments in the future work because they create a perception of loss in the present. Moreover, these immediate pressures actually block attention to even longer term investments such as retirement planning.
Let me emphasize that I am not arguing that everyone should stretch out their mortgages in order to pay into retirement accounts—this is one of those areas where financial planners (and their software) really are required to assess the effect of interest rates, time scale, and amount of the two vehicles. My point is that retirement planning, even on those occasions when people try to plan for the far future, faces a natural psychological disadvantage. Mortgages and similar debt-repayment contracts are tremendous tools of self-discipline, as they create a long-term commitment and enforce this not only legally through the binding contract but also psychologically through the constantly looming loss that is represented by the debt. There are many consequences of this, but the most relevant consequence is that current repayments are both highly motivating and consuming of attention.
Reducing a mortgage feels like cutting a slice off the looming loss that hangs over us today, and this elimination of a loss is so much more concrete, emotionally compelling, and demanding of time and attention than planning for creating gains in wealth that will provide pleasure in 40 or 50 years. Therefore, for your far future retirement needs to get any attention, you have to sit down and take the same kind of self-commitment steps for retirement funds as your mortgage gives you. For example, Richard Thaler and Shlomo Benartzi have shown that a “Save More Tomorrow” approach that provides automatic increases in retirement savings with each increase in salary can have dramatic effects on saving participation and saving rates. Providing employees with a default retirement plan that starts automatically when they join a new organization also has dramatic effects as the biggest challenge is getting new employees’ attention to actually make decisions about the far future5.