More thoughts on planning for retirement

I was talking to my accountant about planning for retirement and he mentioned that there is one thing that young people and my people age do not plan for when we think about retirement. He mentioned that people including sonic boomers have roughly $3,000 to $6,000 in medical bills not covered by any plan. He also said that many of his clients who are living on just Old Age Security and the supplement are sitting on homes that are paid for, and if sold would help the person have a better quality of life. He said that when he mentions this his clients respond with this sentiment: I would love that but if I do, what would I leave my children?" 

So poor planning and misguided sentiment (in my mind) leave people living in poverty or near poverty. I am sure that people understand the need to save, I am not sure why they don't save. That is why I found the ideas expressed by Olivia and Stephan interesting, I hope you do as well.

What might explain this apparent inability to plan properly for retirement? People try to save for retirement, but they too often not able to execute intentions. In a sense, saving for retirement requires behaviour similar to those undertaken in other behaviour modification programs such as exercising, dieting, quitting smoking, or following through on New Year’s resolutions. In other words, a key obstacle to saving more is not necessarily a lack of awareness, but rather the ability to take action on the knowledge.  Here are some reasons why this happens.

People understand their inability to act even when they have good intentions and often seek to protect themselves through the use of commitment devices, or mechanisms that help foster desirable changes in behaviour.

“Pay yourself first” is one of a number of standard commitment device used by financial planners and others who want to encourage disciplined saving and budgeting. Other commitment devices include tax refunds and Christmas or other Clubs, where individuals engage in economic activity that on the face of it are not economically sound (e.g. loaning money to the government or to their local banks at below-market rates). What the individual gets in exchange is a disciplined approach for accumulating savings. Another commitment device that is used by the government is to impose high penalties and withdrawal restrictions on retirement plans. The idea is that once the money is allocated to these plans, a psychological and financial hurdle is imposed on the individual accessing the money, which will help to counteract lapses in personal willpower.

People can be easily influenced by decision framing. In traditional economic theory, it is assumed that rational economic agents (individuals) would not be expected to vary their responses to a question based on how it is asked. We know this is not the case. The simple rephrasing of the saving question elicits a different response in plan participation rates. Researchers have shown that when workers when faced with the option that requires them to sign up for a savings plan then they do nothing. If the employer institutes an automatic enrollment plan (that you can opt out of at any time) with a saving rate specified by the employer or the union more people save at the rate specified by the employer. This behaviour is explained by the idea that when confronted with difficult decisions, individuals tend to adopt shortcuts that simplify the complex problems they face. One simple shortcut is to accept the available default option—i.e., rather than making an active choice, accept the choice made by others. For one large US firm, plan participation rates jumped from 37 percent to 86 percent for new hires after automatic enrollment was introduced.

Evidence reveals another anomaly about individuals and their saving behaviour: the important impact that inertia or procrastination plays on decision-making.  Researchers have concluded that many of us follow “the path of least resistance” in our decision-making. We make the easiest, rather than the best, decision. This passive approach to decision-making is indicative of individuals being somewhat imperfect rational economic agents in their retirement and savings decisions, especially when there is a great amount of choice.

Offering workers many investment choices can produce choice overload; faced with complex investment choices, some participants may elect to simplify the decision by following their default plan, i.e., don’t decide, don’t join the plan, or find out what friends at work are doing. Many of our saving decisions can be strongly influenced by peers.

Just as our saving choices can be affected by framing, so too can our investment decisions be influenced, sometimes strongly, by framing effects.