Procrastination
Closely associated with self-control, procrastination is the tendency to postpone unpleasant tasks. Instead of engaging in a goal-achieving activity such as retirement planning that involves complexity and may lead to frustration, people often opt for a stress-relieving activity such as watching a favorite television program. Herbert Simon, another Nobel Laureate related procrastination to “cognitive laziness” which is the attempt by individuals to avoid the hard work of thinking through a problem.
Inertia
Procrastination in turn produces a related psychological force known as inertia, which is the resistance to change. This resistance often is the consequence of what is known as “loss aversion”. This is the tendency of decision-makers to put more emphasis on what they could lose rather than how they might benefit. A key finding of behavioral economics is that people weigh losses significantly more heavily than gains. Some estimates peg the ratio at 2:1. In other words, losses generate twice as much psychological pain as gains yield pleasure.
Loss aversion affects saving decisions because once households become used to a certain level of take-home pay, they tend to view reductions in that level as a “loss”, even when it is the result of increased savings. Compounding the challenge, saving for retirement involves a difficult trade-off between current and future consumption. The evidence is clear that most individuals have a strong preference for the immediate rewards of spending today over the future payoff of enjoying an increased standard of living in retirement.
Solutions:
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 (SMarT) is intended for employers who want to increase employee savings rates in 401(k) type plans. One feature known as “automatic escalation” however 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 that it requires a change of behavior rather than a change of attitude or an increase in computational skills. These 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 is 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 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.
Fortunately, 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 senseand yes, also some self-control.
This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.
