The science behind why we are bad at saving for retirement

According to a recent study, Hong Kongers believe that HK$8.6 million (US$1.1 million) is the amount needed for a comfortable retirement. However, the study also revealed that seven out of 10 people in Hong Kong anticipate the need for a part-time or full-time job after retirement, despite their desire for a leisurely post-retirement lifestyle.

One possible reason for this is the significant difference between the expected post-retirement expenses and the amount available in their MPF funds, which was found to be a staggering HK$2.4 million in the survey. This issue is not unique to Hong Kong, as the World Economic Forum predicts that the global retirement savings gap will reach a staggering 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 HK$10,000 today or waiting a month to receive HK$11,000. If you’re like most people, you would choose the HK$10,000 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 retirement funds. Despite being constantly reminded of the advantages of starting early, many people hesitate when it comes to actually funding and investing their accounts. Procrastination sets in, and “I’ll do it over the weekend” becomes “I’ll do it when I have time”. Before one knows it, this delay causes years to pass by, forgoing the opportunity for compounding to work in our favour. 

The hesitation doesn’t stop at the planning stage. 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 HK$10,000 gain in your portfolio, and the day goes on. Flip it around with a HK$10,000 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. Hong Kong investors are reluctant to abandon cash, as they only consider reallocating into investment products when interest rates come down to 2.4% or below, according to the survey by the Hong Kong Investment Funds Association. 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 and MPF 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.

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Risk Warnings

Investment involves risk. Past performance is not an indicator nor a guarantee of future performance. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. 

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