In our last article, we discussed specific obstacles that can get in the way of securing a comfortable retirement. In this article, we’ll offer some solutions to help improve those chances.
Fortunately, the study of the behavioral forces that result in poor decisions has enabled researchers to develop strategies to employ those forces to produce better choices and financial outcomes. A program designed by behavioral economists Shlomo Benartzi of UCLA and Richard Thaler of the University of Chicago does just that. Their program, called Save More Tomorrow, or SMarT, is intended for employers who want to increase employee savings rates in 401(k)-type plans.
One feature, however, known as “automatic escalation,” can easily be adapted by the average person saving for any important future goal.
The idea is to automatically increase savings from the employee’s paycheck with each future salary increase. This simple tactic can avoid the psychological barriers that impede individuals from achieving what they want: minimum pain today and larger account balances at retirement. It uses what could be considered a “behavior first” approach meaning it requires a change of behavior rather than a change of attitude or an increase in computational skills.
Here are some of the benefits.
It’s simple. It eliminates the complexity of making difficult assumptions and calculations. It is a yes-or-no decision. You either commit to it or you do not. Once committed, you know that 30%, 50% or more of each pay increase will be “swept” into an investment account. All the calculations are complete, and the hard work is done.
It’s pre-determined. Because of the psychological barriers of lack of self-control and procrastination, most of us find it easier to imagine and commit to doing something difficult in the future rather than right now. Pre-commitments are a way of avoiding the inevitable temptation of the moment (when the cash is in our hands), and our inclination to procrastinate on matters that have an immediate cost but a future reward.
It’s painless. Inertia can be triggered by several factors, one of which is hypersensitivity to loss, or placing more weight on the pain from the potential loss than the benefits from the potential gain. In the savings context, people hate to see their take-home pay go down. The automatic increase program does an end-run around these powerful psychological forces.
In their book “Nudge,” authors Richard Thaler and Cass Sunstein applaud the success of the SMarT program, in general, and the automatic escalation feature, specifically: “By synchronizing pay raises and savings increases, participants never see their take-home amounts go down, and they don’t view their increased retirement contributions as losses. Once someone joins the program, the saving increases are automatic, using inertia to increase savings rather than prevent savings.”
Simply put, it is easier to keep on doing what you have been doing than it is to change.
Behavioral economists have identified the obstacles humans face when making financial decisions involving complex problems surrounded by uncertainty, and require an immediate sacrifice for an uncertain payoff in the distant future. That is to say, precisely the elements households face in planning for retirement. As humans, we fall prey to a combination of psychological forces that lead us to make poor choices.
Luckily, the same factors that hinder individuals from making wise choices are now being employed to help people improve their chances of securing a comfortable retirement. Committing to save a substantial portion of future pay increases is one of the simplest and most effective strategies to do this. It does not require superior skills or an advanced degree, just a little common sense. And, yes, some self-control.
John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com.