The coronavirus is dominating our attention so pervasively in the present moment that the notion of retirement seems even more distant for savers. That’s understandable—natural, even. But it’s precisely our fixation on the present that causes us to struggle to follow through on our intentions to secure our future. Let me show you why.
I have a proposition for you: I’d like to give you one of two gift certificates to your favorite restaurant (that is sure to reopen when the quarantine is lifted). But first, please picture that inviting atmosphere at 7:00 p.m. on a bustling Saturday night, the thoughtful waitstaff, the right musical backdrop, and the perfect meal in front of you and your ideal dinner companion. Now, choose between a $200 gift certificate you would receive today or a $400 gift certificate you would receive 10 years from now.
Time’s up. Which did you choose?
Unless you’re gaming the system – that is, you’re anticipating a financial advisor would never encourage seemingly impulsive behavior over deferred gratification – you almost surely chose the $200 gift certificate today. I would too. Lord knows we’re going to be ready for a night on the town when we return to public life! And that doesn’t make us wasteful or foolish. It makes us human.
To be clear, our all-so-human behavior isn’t inherently foolish or wasteful, especially in this instance. After all, your tastes could change 10 years from now. Another new restaurant could come into town. Heck, your favorite restaurant could shutter its doors, making your gift certificate worthless! A guaranteed two hundo today is almost certain to win over $400 a decade from now for most of us.
This tendency is a cognitive bias called hyperbolic discounting. It suggests that we’d prefer having something today rather than tomorrow, and that our bias for the present only compounds the further away on the calendar we place our hypothetical tomorrow.
But hyperbolic discounting moves out of the hypothetical and into reality when we examine it within the context of saving for retirement. Psychologically – biologically, even – we’ll generally default to today over tomorrow, and the result is that a generation of retirees hasn’t saved enough to meet their goals in retirement.
The odds were stacked against future retirees when the 401(k) was introduced. Think about it. You’re enduring one of life’s more stressful endeavors – starting a new job. You’ve exhausted your mental capacity and willpower on a long series of important decisions. After selecting tax withholding, choosing health insurance coverage, and navigating an array of other benefit options, you arrive at your 401(k) or equivalent retirement plan. And this is how your brain hears the question:
“Would you like to further reduce the amount you can spend today by setting even more money aside for a day decades in the future that might never come?”
How many people do you think opted-in to a 401(k) within the first six months of work? The numbers are atrocious – one study found 34%. But then, inspired by behavioral economists, companies started using an opt-out mechanism, requiring new hires to choose not to set aside at least a modicum of savings. The numbers shot up.
That sounds great, but our bias to choose the default doesn’t actually address hyperbolic discounting. More people may be saving, but they still aren’t saving enough. How, then, can we solve the hyperbolic discounting dilemma? Can we rewire ourselves to prefer saving more?
The answer, according to extensive research by Hal Hershfield on the subject, is to picture yourself in retirement. In one of his studies, Hershfield showed that digitally altering images of present-day participants, extrapolating what they might look like years down the road, could positively affect their saving behavior.
Furthermore, we can employ our imaginations to animate those future images. What do you most want to be doing in retirement? How do you want to feel?
In other words, to save more, we should first think about the lifestyle we want in the future and then back into the financial decisions required to make it a reality. And the degree to which these visions of our future self are vivid and positive will increase our propensity to save more.
Now, back to our initial proposition. The notion of $200 to spend today or $400 to spend 10 years from now isn’t so outlandish. If you’re earning an annual average return of 7% – a reasonable expected return for a balanced investment portfolio – your money doubles in roughly 10 years. And in retirement, it’s precisely stuff like food – and housing, transportation, travel and recreation – that add up to the lifestyle we desire.
So, wherever you are on the continuum from now until your personal retirement then, consider using your imagination to help increase your motivation to save for the future.