Emotional investing and reticence to plan, the psycho-social aspects of financial wellness.

Why do investors behave as they do? Investor behavior often deviates from logic and reason. Emotional processes, mental mistakes, and individual personality traits complicate investment decisions and increase the difficulty of comprehending clients’ judgments. Behavioral decision-making can also have a detrimental influence if investment professionals ignore or fail to grasp this aspect of decision-making.

Financial literacy, propensity to plan, and future focused mindsets are directly associated with optimal retirement planning behavior. At Retirement DNA, we believe that education is at the core of good financial planning. That’s why we offer the Financial Wellness program to businesses whose teams have access to retirement options like 401Ks and other SERPs.

The psychology of planning is complex and wrapped up in many well-studied behavioral predispositions.

Researchers across disciplines of psychology have focused attention on the impact of the retirement process on post-retirement adjustment and well-being. This year, 2021, marks the year that the youngest Baby-Boomers (born in 1956) will reach retirement age (65). The influx of retirees into the economy and into the social fabric of the country will shift many aspects of saving, spending, and our general perception of what a healthy retirement looks like.

We hope that by addressing the elements that contribute to a head-in-the-sand approach, we can help younger people plan earlier (and smarter) and also, help business owners set up the kind of plans and financial education that will bring value to their employees and articulate the kind of caring culture that inspires cohesion and optimal performance. Financial education and retirement planning have not kept pace with the changing habits of the workforce. Part of that is tied to the psychology behind planning and investing.

We are all emotional investors.

We believe the familiar is better, we think what we own is worth more and that there will always be a better upside on the horizon. Actuarial data indicate otherwise but it is very hard for our emotional brains to parse all the data and make savvy choices at the right time.

According to research from the National Institutes of health, at the present time, approximately 50% of the working population envision either a full retirement, a partial retirement with some level of continued earning or they speak to changing jobs as their long-term retirement solution. The remaining 50% say they will either, “never retire” or have no plans. The fact is, most people do not possess the financial knowledge to make well-timed and optimized savings and investment decisions. Additionally, financial planning doesn’t exist in a bubble. To engage in financial planning for retirement, the factors of income, career, and health all come into play. What we see is that, even with optimal life, career, and health situations, there remains a reticence to discuss aging, financial plans, and goal setting, making the conversation around financial planning for retirement a challenging one in the best of circumstance.

For employers setting up retirement contribution options for their teams, addressing this reticence can be as simple as a regular cadence of financial wellness education without pressure to act. It has been shown that financial planning is not something that is affected in short bursts but over the course of an entire career, this influences coming from employers, friends, financial wealth advisors, and other trusted figures in an individual’s life. Incorporating financial wellness education can relieve stresses from the employee workforce that reduce productivity and increase stress responses. A stressed workforce is less productive and more likely to change positions, increasing costs for employers.

From a national perspective, financial wellness education is in short supply.

Schools and even universities offer little in the way of financial planning and investment preparation to young people. Because of the lack of early education, workers enter careers with little to no vocabulary to address financial retirement planning. It is therefore left to employers to provide resources or leave the workforce to flounder on their own (as referenced above, this can lead to lower productivity and decreased job satisfaction as well as high stress from financial concerns that reduce workplace efficacy).

To truly address the individuals’ reluctance to plan for retirement in conjunction with their lack of knowledge around the options that exist, we have to look at some of the socio-emotional factors that affect the ways in which we address financial planning. For example:

• Clarity of financial goals
• Retirement-related anxiety
• Perceived social norms
• Availability of voluntary retirement saving programs
• Tax incentives for saving

Solutions to this reluctance to plan for retirement lie in regular education, frank open conversations, and strategic offering of financial wellness education. In order to address the psycho-social bias that affects every investor, it’s important to know what we are up against.

Here is a brief overview of the areas in which most people experience bias in investing and financial decision-making:

Confirmation Bias 

Confirmation bias occurs when someone is biased towards making a decision that favors the actions they have already taken or a belief that they already hold their new decision confirms their previous actions bringing comfort and familiarity to the new choices. Confirmation bias causes people to make decisions based on flawed or incorrect information. 

Familiarity Bias 

Similar to confirmation bias is Familiarity bias. Familiarity bias occurs when investors choose to make decisions based on industries they understand as opposed to a company whose technology is new or un-familiar. This may entail investing in local or domestic companies. It also may include avoiding taking advantage of newer investment opportunities that should receive equal consideration. 

A potential  outcome from the familiarity bias is that investors assume additional risk by failing to pursue a diversified portfolio or failing to invest in emerging technology that is outside the investors realm of knowledge. 

Experiential Bias 

Experiential bias occurs when people or investors are worried about events that have happened in the past occurring again, they have experienced an event and now believe it is the norm or doomed to repeat. This increased belief that certain events will occur again may be responsible for people acting in a way that avoids potential risk factors as a result. 

A prime example of this is that many people chose to abandon the stock market after the extreme effects of the financial crisis in 2008 and 2009. As a result of their experiences, many had negative perspectives of the stock market as a whole and had fears of taking additional risks for fear of another downturn. 

Loss Aversion 

Loss aversion occurs when investors are more concerned about what they could lose than identifying the potential gains available to them. While it is important to carefully review the risks associated with certain financial choices or investments, one’s willingness to take on a certain amount of risk is critical. 

Disposition Effect

Similar to Loss aversion is the disposition effect. This occurs when an investor is unwilling to accept their loss. Oftentimes inventors choose to sell their top-performing investments and hold onto those that are not performing well. They do so with the hope that it will eventually return to its purchase price to at least break even. 

All of these psycho-social influences on the way people interact with their investments and plan for their retirement work against the logical choice which is to start young, stay the course, and let time and intelligent investment opportunities optimize your money and create the kind of comfort in retirement you will want and need.

When you’re ready to start educating your team about the advantages of retirement planning, reach out to us.

Talking about money can get uncomfortable fast. While planning for retirement is the most logical step in creating the future you desire, there are unconscious roadblocks many people have to overcome to heed the advice of their financial planners who are successful often self-describe as both planners and pseudo-therapists.

With these facts in mind, the CFP exam is now incorporating psychology into the requirements for certification (starting in 2022).

Many people find that, as they approach retirement, they have not accounted for the lifestyle they want to maintain and wish they could change spending or saving habits earlier in life.

In 2019 a study from the Employee Benefit Research Institute found 40% of American households between 30 – 65 will run out of money in retirement, with 67% of millennials having nothing saved for retirement at all. To be fair, most young people have a hard time imagining 5 years from now, much less 45 years into the future.

The good news is, with proper motivation, small investments compound, creating huge retirement savings, if you start in your 20s. All is not lost for those of us well past that age, but sharing these insights with the younger generation is a gift we can give them.

So, what can motivate a younger person to save for retirement when life is so fun (and budgets are so tight) right now? One student tried bringing young people face to face with their retirement-aged selves. They took photographs and, using computer imaging software, aged them. When faced with their future selves all participants agreed that saving fro retirement was now a priority.

The student project was based on a 2011 study by social psychologist Hal Hershfield, who showed that, faced with an older version of themselves participants chose to put away more for retirement than those who had not seen the aged version of their own face.

At Retirement DNA, we know that the building blocks of retirement are based in sound planning, wise investment, and good financial education. That’s why we conduct custom plan audits to review where you are, where you want to be, and how we can help you get there.