As humans we have been gifted with a great sense which makes us different from the new age robots – EMOTION! The artificially intelligent robots today can manage most of the (or in some cases more than) activities that we humans perform. However, what makes us totally unique is Emotion. Unfortunately, it is this very emotion that also leads to biases within us which can hamper our decision-making process.
The 2 most important biases that effect our retirement planning are myopia bias and optimism bias. Myopia bias is the bias of short-sightedness. We tend to ignore things that are far away and believe there is always going to be enough time. The second bias, which is optimism bias leads us to believe that no negative outcomes are going to come in our lives. Both the biases play a very important role in our retirement planning.
What is Retirement?
Before we go further in explaining how our emotional biases effect our retirement planning, let’s try and understand what retirement is. Retirement is the action of leaving one’s job or occupation. In other words, it is the stoppage of cash flows from an individual’s working life.
When we speak of retirement, people tend to think of an age of 60 or 65. However, retirement could be temporary or partial as well. And this could occur much earlier in life. For understanding this, let’s take the example of a working woman who gets married at 25. 3-years later they plan to have a baby. At 28 when they have a baby, the lady may have to stop working completely for some time or may have to take a less strenuous job. This is no different from retirement.
In some cases, such circumstances may be unplanned. Imagine a 45-year old man living in a big city with a handsomely paying job. His father, who still lives in his hometown has a serious medical condition. The man gives up his job or takes something much less paying. This is no different from retirement either.
Why Retirement Hurts?
We must understand that for life to go on, one must meet some certain expenses right throughout. Other than the regular certain expenses, there are also situations where the expenses increase without much planning – like in the second case mentioned above. What’s worse is that the regular cash flows stop or reduce during retirement.
Expenses > Income
Retirement Planning Biases
Let’s get back to the 2 emotional biases we had discussed earlier - The myopia bias and the optimism bias.
- Myopia bias – Human beings tend to have a bias of short-sightedness. We like to predict and plan for things that are in the near future and tend to ignore the distant. This is very evident from the excitement generated when one has to plan a vacation 3-months away. But when it comes to planning for let’s say a vacation that is 2 years away, we often think its too far and we have enough time. In fact, if one is to plan early, the commitment in terms of investment allocation can be really low as it gives you more time to accumulate gains.
- Optimism bias – There is a common feeling amongst humans that nothing bad is going to happen to them. And even if they are to believe that problems can happen, they would hardly ever want to think or talk about it. They prefer to be optimistic about everything. Unfortunately, as explained above, when trouble comes it increases the outflow and decreases the inflow. Hence, this plays a very big part in improper retirement planning.
Urgent vs Important
The myopia bias leads us to mix up what is urgent and what is important in investment planning. Retirement planning in India has suffered more so because for Indians, saving for kid’s education and future has always been the priority. As kids start to grow up, Indian parents start to worry about their education fees and payments for their various extra-curricular classes. Only because this is urgent it starts appearing as important, and retirement planning which is genuinely important takes a backseat.
Also, another priority for Indians has been to save for their children’s weddings. The day a daughter is born, the parents are expected to start saving