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These 2 Behavioral Biases Could Mean Up to 70% Less in Retirement.

Byline: Emily Zulz

Being aware of one's biases could mean a significant increase in retirement savings, according to a study from the National Bureau of Economic Research.

The study looks at two common biases that can affect how one saves for retirement -- present bias, the tendency to put more value in current or short-term decisions than the future, and exponential-growth bias, aka the tendency to underestimate and neglect the power of compounding investment returns.

"A person with present-biased preferences may intend to save more in the future but never do so," the study states, adding, "a person with exponential-growth bias will underestimate the returns to savings and the costs of holding debt."

As the Center for Retirement Research at Boston College points out, "this study helps us to understand why, as well as how much" our biases matter.

"The people who are not present biased had, on average, about 19% more in savings than those who value tradeoffs much differently over the short term and the long term," the Center for Retirement Research said in an examination of the NBER study. "Those who accurately perceived the power of compounding had about 20% more than those who neglect compounding completely."

While behavioral biases' effect on retirement savings have long been studied, this is the first study to establish a link between self-awareness of these biases and economic outcomes in retirement savings.

"It has been suggested that self-awareness regarding one's biases may be as important or even more important in determining behavior than the direct effect of the bias itself," according to the NBER study.

Being self-aware of one's biases could lead to a 12% increase in overall retirement savings -- or as much as a 70% increase using estimates that account for classical measurement error, the study finds.

"Self-awareness has the potential to mitigate the impact of the biases," the study states. "For instance, a person who is aware of her EGB could rely on the market to acquire tools or seek advice, and a sophisticated present-biased person could use commitment devices to control the impulses of her future selves."

Thus, the study -- which was researched by a team of economists from Stanford University, the University of Minnesota, the London School of Economics and Claremont Graduate University -- finds that lack of self-awareness of one's biases has an additional independent negative impact on retirement savings.

Not only does the study find that present bias and exponential-growth bias are "statistically significant" and "economically meaningful" factors of retirement savings, but it also finds that a significant portion of people suffer from one or both biases.

According to the study, 55% of those surveyed had present bias and about 70% had exponential-growth bias.

NBER's analysis is based on a sample of more than 2,300 people, where the average age was 49, in online surveys in 2014 and 2015.

NBER also looked at these biases' effects on employer-sponsored retirement accounts, and found that there is evidence that both behavioral biases can decrease saving flows. The good news is that NBER found no evidence that these biases affect the equity allocation in retirement accounts or the enrollment in employer-sponsored retirement plans.

(The study, The Role of Time Preferences and Exponential-Growth Bias in Retirement Savings, is copyright 2015 by Gopi Shah Goda, Matthew R. Levy, Colleen Flaherty Manchester, Aaron Sojourner and Joshua Tasoff.)

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Publication:ThinkAdvisor
Date:Apr 7, 2016
Words:571
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