Saving for retirement: Overcoming human biases and knowledge deficits

 
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The societal shift from defined retirement benefits (pensions) to contribution retirement savings mechanisms — for example, the 401(k) — has placed a greater burden on the decision-making capacity of Americans. As this dynamic continues to unfold, evidence suggests that many people are not making wise investment choices for their retirement money.

Traditional economic theory assumes that individuals are able to rationally manage investment decisions. Behavioral economists, by contrast, often demonstrate that people can make decisions that are less than optimal. They look to human biases and imperfections when explaining the discrepancy between what investors want to and should do, and what they actually do.

A 2010 review of relevant studies by the Social Security Administration, “The Role of Behavioral Economics and Behavioral Decision Making in Americans’ Retirement Savings Decisions,” outlines four key impediments to successful retirement investment decisions:

  • Informational issues:  People avoid choices that involve ambiguity and rely too heavily on anecdotal evidence, particularly when they have limited knowledge of the issue.
  • Biases: They rely on default options or “rules of thumb” and favor the status quo, rather than critically evaluating options.
  • Inter­temporal choice: People favor short-benefits over long-term gains, overvaluing present needs and emotions. This often leads to underinvestment.
  • Decision context: Investment and savings decisions are dependent on context and how options are framed.

The author explains that greater financial literacy, savings incentives, automatic default options that are pre-set to the most optimal outcome and mandated decisions can all help individuals most effectively invest their retirement money.

Tags: retirement, Social Security, consumer affairs

    Writer: | Last updated: March 10, 2011

    Citation: Knoll, Melissa, "The Role of Behavioral Economics and Behavioral Decision Making in Americans' Retirement Savings Decisions," Social Security Bulletin, November, 2010, Vol. 70, No. 4, 1-23. PDF.
     

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