Oxstones Investment Club™by Laura Rowley
It’s National Save for Retirement Week, seven days devoted to call attention to an issue most Americans are negligent about. In fact, a survey released this week by TIAA-CREF found that 93 percent of Americans realize that saving is essential for financial security. But 82 percent say they don’t know what it takes to reach their goal, and about four in 10 aren’t saving at all.
“There’s a big fear of the unknown,” says Joe Wilson, an Atlanta-based wealth management advisor for TIAA-CREF, a financial services firm that serves employees participating in more than 27,000 retirement plans. “People understand the importance of saving, that’s clear from survey — it’s just about understanding what the next steps are and what options they have.”
There’s also the small matter of finding the cash to save when incomes for most people are relatively flat and the costs of food, utilities, gas and health care are rising. While the national savings rate jumped to 5.8 percent in September, that’s not because poor and middle-class people are stashing cash in bank accounts, economists say.
“The savings rate has always been driven largely by the affluent,” says George Loewenstein, behavioral economist at Carnegie Mellon University. “For a while they had cut back on saving because their assets — most recently their houses — had appreciated so much they were saving without saving, and could (cash out their equity) and spend it. But when the housing market crashed, the affluent segment of society realized it had to do the real hard work of saving.”
The personal savings rate doesn’t include retirement contributions, but a recent study measuring those accounts shows most workers falling short of their goals. Financial Engines studied 2.8 million participants in 272 employer plans and found nearly three in four 401(k) participants will be able to replace only 45 percent of their pre-retirement income — versus a goal of 70 percent. That’s based on their current balances, plan contributions and projected Social Security benefits.
We all know the virtues of brown-bag lunches and carpooling to boost savings. So here are a few strategies from behavioral economists that might help feather your retirement nest:
Translate Short-Term Behavior Into Long-Term Results
Saving for retirement is difficult because the pleasure derived from the money is delayed and intangible — and it’s hard to imagine how putting away a few bucks now can make a difference later. Loewenstein says the key is to think big picture.
“In so many situations it’s not short-term versus long-term — it’s the drop-in-the-bucket problem,” he says. “If you’re trying to save $500,000 for retirement and you’re facing the question of whether you should have a $4 latte, you might as well have it, right?” That small indulgence hardly registers an impact.
Solution: Try this calculator, which shows savers how small daily sacrifices can add up to big dollars in retirement.
Understand How You Frame Goals, and Plan Accordingly
Research has found consumers tend to think about goals in two ways: “High-level construal” focuses on the why — i.e., “I want to save for retirement because I want to spend those years relaxing on the beach.” By contrast, “low-level construal” focuses on the how — i.e., “I want to save for retirement, so I need to figure out how to invest my 401(k).”
One study found that when asked to put a specific dollar figure on a goal, the big-picture (“how”) folks were more successful at saving, because they focused on the target, while low-level (“why”) construers easily discouraged low-level (“why”) construers.
If you think about objectives in a big-picture way, try a retirement calculator like this one to put a real number on your goal. (Or spend a half hour with this tool created by Boston University economist Laurence Kotlikoff.)
If you’re a detail person, keep it simple: Join your firm’s 401(k) plan, contribute at least enough to get an employer match, and boost the contribution by 1 percent every time you get a raise. Choose a life-cycle or target-date fund, which offers an investment mix tailored to your age or retirement date, if the plan offers it. Don’t focus on reaching a specific number, because it may discourage you from trying to save at all.
Spread Savings Behavior Through Social Networks
Decades of research underscore the power of social contagion. A study in the New England Journal of Medicine, for example, found that if a friend becomes obese, you have a 60 percent higher chance of similar weight gain. On the upside, another study found a decision by one person to join his employer’s retirement plan clearly influences co-workers’ decisions to do so.
There’s no reason you can’t find additional savings by applying social contagion to other settings. Dan Ariely, a behavioral economist at Duke, gave an example from his North Carolina neighborhood, where a group of parents were gathered at a birthday party.
“One person said, ‘Look, the kids want a birthday as nice as all the other kids — but all they really want is a chance to run around together. If we all just scaled down, they’d be just as happy,'” recalls Ariely. The suggestion worked, and the neighborhood birthday parties are now more low-key and less costly.
Automate, and Get Help
Perhaps the most effective retirement plan is one that flies on autopilot. In 2007, the Department of Labor approved rules allowing employers to automatically enroll new employees in retirement plans (unless they opt out), and to invest the money in a mix of investments geared to their age and projected retirement date. Those plans have been a boon to younger, lower-paid workers.
Financial Engines found that 52 percent of workers under 30 in default plans have the appropriate risk and diversification for their age, compared with just 12 percent of their peers in plans that don’t offer that option. For people earning less than $25,000 a year, the figures were 50 percent and 24 percent, respectively.
If your firm doesn’t offer a default investment option, get some advice on how to invest. A separate study by Financial Engines found the median return for participants who got professional investment help offered by their employer was almost 2 percent higher than those who did not.
It doesn’t sound like much — but it adds up over time. A 45-year-old who gets help will have saved 47 percent more by age 65 than a peer who doesn’t, assuming the 2 percent higher median annual return is maintained over the 20-year period. For a 25-year-old, the difference is more than 100 percent. (If your employer doesn’t offer advice, find a fee-only financial planner.)
Finally, if your employer doesn’t offer a 401(k) plan, check out my blog for a how-to on individual retirement accounts.
Tags: 401K, retirement, savings, strategies