The science behind why we are bad at saving for retirement

The original version of this article first appeared in The Business Times. 

As many as a quarter of Singaporeans surveyed have yet to start planning for their retirement, with the top reason being that they prioritise immediate financial needs. In the same poll, three in four Singaporeans said they would start planning at the age of 35. In fact, Singapore isn’t the exception – the World Economic Forum expects the global retirement savings gap to increase to US$400 trillion by 2050.

As it turns out, science has shown that our brains can often hold us back from sound financial decisions. How can we overcome our innate cognitive biases to fill the retirement gap?

The marshmallow test

Traditional economics and academia have long assumed that humans are rational beings, making decisions based on logic and maximising utility. But behavioural scientists believe that humans are predictably irrational, and systematically make choices that defy clear logic.

Consider the following scenario: You are faced with a choice between receiving S$1,000 today or waiting a month to receive S$1,100. If you’re like most people, you would choose the S$1,000 today. This preference for immediate gratification over future gain is known as present bias or hyperbolic discounting.

If one recalls, that’s almost like what the famous Stanford marshmallow experiment wanted to find out about success traits among children with delayed gratification.

Many people tend to sharply discount future rewards in favour of immediate gratification. As an adult, present bias is probably one of the largest obstacles to saving for retirement because we value the “now” over the “later”. And, the temptations in question have grown way more complicated than merely one or two marshmallows.

“I will do it over the weekend”

In our mind, it’s not only the current joy that hauls us towards such a choice. Our innate preference for sticking with the current situation, rather than taking steps to make a change, is deciding for us. It’s easier to take the path of least resistance and do nothing.

What’s called status-quo bias explains why automatic subscriptions can be dangerous. The tendency is to fall prey to inertia and continue using them if we have to take action to make it stop. Of course, procrastination kicks in, too.

The investing example that I always refer to is with our SRS (Supplementary Retirement Scheme) monies. As we approach the year-end, we are reminded of the Dec 31 deadline to make SRS contributions to enjoy tax relief. Yet, when it’s time to pull the trigger and actually fund the SRS account or invest the SRS monies, some people still falter. “I’ll do it over the weekend” becomes “I’ll do it when I have time”. Before one knows it, one has almost missed the deadline for contributions to be eligible for tax relief.

The hesitation doesn’t stop at the top-up stage. As at December 2023, a shocking 19% of SRS funds are still in cash, earning a minimal 0.05% interest rather than being invested. Some convince themselves that they need more time to familiarise themselves before taking the next step. Discomfort also looms when seeing the static savings figure start to fluctuate.

Dodge losses and you may miss wins

In addition to all the above, we feel the pain of losses more acutely than the joy of an equivalent gain. See a S$100 gain in your portfolio, and the day goes on. Flip it around with a S$100 loss, and you start to wonder where things went wrong. This is widely known as loss aversion.

Fear of loss is a powerful emotion that can prevent us from taking well-calculated risks, and prioritising short-term security over long-term wealth accumulation, which comes at the cost of higher investment gains in the long term.

With decades until retirement, one may be overly allocated in cash and fixed income. Singaporeans still tend to allocate very conservatively and rely on low-risk instruments to prepare for retirement. A survey reported that the top two ways Singaporeans prepare for retirement are through savings accounts (61%) and CPF (56%). But even retirees may still need some equity allocation to help beat inflation over a lengthy retirement.

Make it easy

Behavioural economist Richard Thaler and legal scholar Cass Sunstein believe that people have two modes of thinking: one is intuitive and automatic, and another is reflective and rational. The two modes may sometimes clash, as the former likes keeping the status quo and instant gratification, whereas the latter may grasp the need to save and invest for retirement in the future.

Knowing the importance of retirement planning isn’t enough. We need to acknowledge our innate cognitive biases and the psychological pitfalls our minds are vulnerable to when it comes to taking actions that will benefit us in the long term.

As Thaler says: “If you want to help people accomplish some goal, make it easy.” If we can frame decisions in a way that makes it easy for people to gravitate towards the more desirable choice, we can set ourselves up for greater success.

One way is to put the best outcome along the path of least resistance by making investing simple, easy and automatic.

First, create automated monthly investments, where funds are directly pulled from one’s bank, CPF or SRS accounts to reduce the present bias and inertia. Next, find globally diversified portfolios which are monitored by experts and automatically rebalanced to keep it simple and reduce the hassle factor.

The math isn’t hard and the benefits are clear – one needs to save money today to enjoy a financially secure retirement in the future. What stays true all along this journey is how to make a conscious decision not to enjoy the money now, so that it can yield benefits years later in the golden years.