Question: Who is on track for retirement? A 35-year-old farmer or a 35-year-old accountant. This may seem like a simple question, however there’s not enough information for me to give an accurate answer. A person’s career, age and lifestyle is not enough information to see an individuals’ path toward retirement. What we want to find out is how these two individuals’ emotions and behavior influence their financial decisions. Behavior toward investing and retirement can be vastly different due to risk tolerance, biases and retirement perception. Successful investing and retirement planning hinges on making sure we understand how we may react in various scenarios. Let’s go over how our behaviors are affected when it comes to risk, biases and your retirement perception.
Risk – How we perceive risk can be dictated by our emotions. Here’s an example. You go to a casino with 50 dollars and you are an individual who is comfortable with risk. Over the course of the night, you win an additional 50 dollars, giving you a total of 100 dollars. How risky will you be with your next bet? Your risk tolerance might have changed now that you have won some money. On the flip side, what if over the course of the night you lose 30 dollars, leaving you with 20 dollars. How risky will you be now? Depending on how you handle risk, this can cause an emotional decision that could affect your investment strategy or retirement goals.
Biases – In a world where there are seemingly countless sources of information, from various types of news outlets or social media to experiences with past investment performance, our preconceived notions can be fueled or even borne from unreliable sources. Our own investing and retirement planning is not immune to our biases. To some degree everyone has a bias towards how they like to invest. The question to ask yourself is whether you are making the most accurate choice based on data, not bias. Consider your favorite companies. Maybe you love them because they have a great product or service, or maybe you think their ads are clever or funny. Are those solid reasons to invest in that company? We need to acknowledge and understand our biases so that we are better equipped to make the best decisions we can based on all the information available to us.
Retirement Perception- The perception of retirement planning has changed vastly over the last 30 years. There has been a shift in preference from defined benefit plans to defined contribution plans as the primary savings vehicle for retirement income. What does this mean to you? This puts more emphasis on you to plan and save for retirement. The difficult part is knowing how much you will need for retirement. Let’s look back at that original question at the beginning of this post – Who is on track for retirement?. There are quite a few variables you have to consider like age, savings rate, investment allocation, retirement age, life style, and retirement length. The key to fulfilling your retirement goals is to identify these factors early so that you can put a plan in place. But what if your plan for retirement changes over time? This actually happens a lot. Once again, the key here is your plan. If you start planning early, you are in a better position to make adjustments to your retirement plan as your goals change. Now more than ever, it is critical to identify your retirement goals and make sure you put yourself on the right path to get there.
Everyone will have different emotions and behaviors when it comes to their finances. It is important to identify your unique behaviors that can impact the decisions you make about your finances. Risk, biases and our retirement mindset are just a few aspects of behavioral finance that you should discuss with a professional.
Please join us on Nov. 27 for our FIT4Learning webinar as we dive deeper into how these behaviors can affect our finances.