Retirement: the cognitive bias that stops us from saving

As the saying goes, you should never put off until tomorrow what you can do today. It’s sound advice whether you’re ticking items off your to-do list or working towards a major project. When it comes to our retirement, though, many of us seem to put saving off indefinitely. Why aren’t we more disciplined about our pensions? Read on for the myLIFE take on the main obstacles that stand in our way.

Are you one of those people who made a New Year’s resolution to save for the future, including your eventual retirement? If so, we’ll hazard a guess that you haven’t put aside so much as a euro yet.

Of course, there are very good reasons why that’s the case. It’s because of those blasted unforeseen expenses and that unmissable deal on widescreen TV. Plus, your rent went up and the cat had an emergency trip to the vet. But you’ve promised yourself that you’ll really make an effort this time! Starting tomorrow, or next week, or next month at the latest.

Let’s stop making up excuses and recognise that we lack self-control when it comes to managing our money in the long term and saving for a rainy day. It’s time to face up to the fact that you – like most human beings – are more of a grasshopper than an ant. Being aware of this and admitting it will help you break down the barriers that stop you from putting money away.

The majority of the population have trouble setting money aside on a regular basis, whether that means saving up for a holiday, accumulating a house deposit or accruing extra retirement funds. On paper, though, saving a few euros every month should be dead easy for most of us, especially in a wealthy country like Luxembourg. So why is it that so many of us aren’t making any headway?

Behavioural economics has the answers. According to science, several forms of cognitive bias interact to thwart our good intentions. The upshot is that we find it really hard to make the right choices about our finances, particularly if this involves planning for the future and saving up for our retirement or large-scale projects.

When it comes to money, our highly unstable time preferences tend to play tricks on us. In other words, our perception of time affects how we accumulate (or fail to accumulate) wealth.

Most of us have a limited attention span. Hence, even though we are objectively capable of understanding the importance of saving for the future, this concept seems abstract and less worthy of our attention than what appear to be more immediate concerns. Our mind tends to focus on present events and opportunities, which are more tangible. This makes us impatient and leads us to opt for an immediately accessible reward rather than one that seems more distant.

Time inconsistency means that we often prioritise immediate gain over planning for our long-term financial needs

When we’re impatient we tend to spend our earnings right away rather than saving up to achieve a long-term goal. Time inconsistency means that we often prioritise immediate gain over planning for our long-term financial needs. This widespread pattern of behaviour reflects a well-known form of cognitive bias: present bias.

Present bias: how we overvalue instant rewards

A classic test in the form of a series of questions admirably demonstrates how present bias affects the way in which we think about money. Would you prefer to receive €150 in 52 weeks or €125 in 48 weeks? Most people who answer this question have no difficulty concluding that they would prefer to wait four more weeks for a higher reward. Given the distant time horizon and the sizeable difference between the two sums, we rationally opt for a greater gain.

So far so good. But if someone were to ask you right now whether you would rather receive €125 today or €150 in four weeks’ time, what would you say? The premise is exactly the same in both instances: the difference between the two amounts is the same, as is the four-week wait for an extra €25. But we’re guessing that the right answer doesn’t seem so obvious any more. Most people favour an immediate reward: they would prefer to have €125 now rather than wait. But if you said that you would wait in the first scenario, the rational answer would appear to be that you would wait in the second scenario too. What’s going on inside our heads?

The answer is simple: we place too high a value on the present moment. This means that when we think about distant scenarios taking place far into the future, we tend to understand them in abstract terms. It takes more effort and discipline to think them through.

We find it hard to resist the temptation of immediate gain, so we tend to prioritise managing our finances in the short term at the expense of our long-term savings.

Present bias demonstrates our lack of self-control. The influence of present bias is the reason why we always put off making important decisions, including getting our finances in order for our retirement. We find it hard to resist the temptation of immediate gain, so we tend to prioritise managing our finances in the short term. Whereas leisure items and financial products such as credit cards offer us the satisfaction of an immediate reward, investment-style products such as life insurance and retirement savings plans involve immediate costs in exchange for future benefits.

We have a strong tendency to procrastinate when faced with the unpleasant sensation of denying ourselves right now in order to save for a future that seems far off. This is also undoubtedly why some investment products come with tax advantages that promise us benefits now as well as later. Without these incentives, it would be a safe bet that the number of subscriptions would fall sharply, despite the fact that such schemes would still make just as much sense from a long-term savings perspective.

When saving feels like a loss

Unfortunately, this obvious self-control issue goes hand in hand with another form of cognitive bias that makes it even harder for us to make the right decisions about our future: loss aversion. There can be no doubt that this is the most important driver of human decision-making, especially in the field of investment, where it manifests itself as risk aversion. How can we avoid all losses? This aversion is a legacy from our earliest ancestors, whose survival depended on their ability to hold on to scarce resources and live with what they had.

In-depth studies have shown that losing €100 affects us twice as much as gaining €100.

In-depth studies have shown that losing €100 affects us twice as much as gaining €100. Hence, many of us unconsciously experience investing €100 in a savings account as an immediate loss. Once we’ve grown accustomed to a certain level of disposable income, any immediate reduction is experienced as a loss. And this remains the case even if the debited sum is invested for our own future benefit and with the potential to generate interest.

The discomfort we feel when we put money away can thwart our good intentions when it comes time to actually make a transfer to a savings account or set up a standing order to a rainy day fund.

Avoiding the fear of making (the wrong) decisions

There is yet another factor that stands in the way of your plans to save. If you’ve managed to overcome present bias and loss aversion, you still have to face the fear of making (the wrong) decisions.

It’s not enough to put a few euros aside each month to fulfil your savings plan. You also need to know exactly how much to set aside, how often and in what investment vehicle, depending on your profile and objectives. When it comes to savings, the options are endless. Knowing which solution will be the best fit for your personal circumstances in the long run constitutes a huge mental burden. So, when we need to make complex choices that shouldn’t be taken lightly, many of us put off the decision and carry on procrastinating indefinitely. But don’t lose hope just yet! There are plenty of experts out there to help you make the right decisions – starting with your banker.

Recognising your own lack of self-control is the first step towards better planning for the future. Even self-confessed grasshoppers can save up for a rainy day. They just need help to adopt the right mind-set for saving and access to simple and painless solutions.