Immediate gratification can take huge toll on retirement

Dismal market returns haven't exactly created a tail wind for 401(k) and individual retirement account portfolios over the past decade or so, but an equally pernicious and more entrenched problem is that our brains are messing with our retirement plans.

“We are wired for financial defeat. Whatever has the most emotional juice right now is what gets our attention,” said certified financial planner Rick Kahler, a registered investment adviser and president of Kahler Financial Group Inc.

“Invest $5,000 in your IRA for a retirement that is 10, 20, 30 years away? Or spend the $5,000 for a vacation to the Bahamas?” Mr. Kahler asked.

“All too often, the Bahamas wins out,” he said.

Our thirst for immediate gratification can easily take a six-figure toll, said William Meyer, founder of Social Security Solutions.

More than two-thirds of folks opt to claim a lower Social Security benefit, starting as early as 62.

For a married couple, that can mean leaving as much as $100,000 on the table.

“If you wait to claim until age 70, you're locking in a benefit that is 76% larger,” Mr. Meyer said.

TWEAKING THE BRAIN

Forever tweaking an individual's asset allocation probably won't get him or her near the retirement payoff that a brain tweaking will achieve.

Consider these strategies for engaging investors' brains in more-productive retirement planning.

Get them to a calculator, pronto. OK, they know they probably should be saving more for retirement. And when life keeps intervening — that Bahamas vacation they really need or the realization that their kid's orthodontic work isn't covered by insurance — they tell themselves that next year, they will ramp up their savings rate.

What many people don't realize is how expensive time is.

Research conducted by Craig McKenzie, a psychology professor at the University of California, San Diego shows that we have a tendency to “massively underestimate the cost of waiting to save,” he said.

“It's difficult to appreciate the difference between giving yourself 20 years to save and 40 years,” Mr. McKenzie said.

For example, a 30-year-old who is saving $10,000 a year and earning an annualized 6% will have $1.2 million at 65.

Care to guess what someone starting at 45 will have? About $390,000.

The younger saver invests $150,000 more than the 45-year-old does, and in return has an ending balance that is $800,000 larger.

Even if your clients are already past their 20s and 30s, they might find it eye-opening to see how extending their investment timeline by delaying retirement can help matters. Their company retirement plans probably have an online calculator.

Make it personal. How investors frame retirement savings decisions can help boost your ability to delay gratification. When people were asked by researchers if they would prefer to have $3,400 in one month or $3,800 in two months, 57% chose the latter. When the same scenario was framed in terms of one's personal age — “when you are two months older” — 83% chose to wait for the bigger payoff.

How does that translate to better retirement planning?

A 50-year-old who frames a savings goal as “when I am 65” likely will be more patient to focus on that delayed gratification than someone who frames it as a more generic “in 15 years,” said Yale School of Management marketing professor Shane Frederick, one of the study's authors.

Time travel. Another unique challenge for retirement planning is that the end goal is so far away, it's hard to see what impact actions that we take or don't take today will have on our older selves. When researchers showed individuals computer-aged photos of their projected future selves, the human guinea pigs said that they would save more than twice as much for retirement, compared with a control group that wasn't given a glimpse of their older self.

Work is afoot to bring this visual exercise to 401(k) plans.

In the meantime, Hal Hershfield, who led the research, said that he wouldn't recommend using applications that age your face.

“They're just not accurate enough, and I think seeing a strange-looking version of your future self may actually have the perverse effect of causing you to identify less,” he said.

New research that has yet to be published shows that simply writing a letter to one's future self can help people become more invested in the welfare of that older person, said Mr. Hershfield, an assistant professor of marketing at New York University's Leonard N. Stern School of Business.

“In a way, this task is a very low-tech version of the age progression [photo-morphing] techniques. Both have the same goal of creating a more vivid image of the future self,” Mr. Hershfield said.

Hanging out with older folks such as parents and grandparents, or volunteering with an organization for the elderly, also can have a beneficial impact on the resolve to save more today, he said.

Channel Ulysses. Most of us suffer from a bad case of recency bias, the tendency to extrapolate that whatever is happening today will keep happening. That is why it is so hard to buy low and sell high. If one's recent experience is a falling market and bad returns, it isn't exactly easy to belly up to the bar and buy stocks or simply stay committed to what one already owns.

A Ulysses contract — a one-page statement that lays out one's long-term strategy and the fact that one is committed to staying the course — can be a line of defense against overreacting to current events. Like the Greek warrior, individuals preplan for how they will circumvent emotional sirens that can thwart retirement plans.

For example, a sample Ulysses contract — created by the Allianz Global Investors Center for Behavioral Finance for financial advisers to use with clients — includes this passage: “Should the portfolio value decline by 25%, we commit to avoid the urge to panic and sell the portfolio. Similarly, should the portfolio value increase by 25%, we commit to avoid the urge to chase the hottest investments.”

Another useful step is for individuals to include a clause in their contracts saying that before they ever deviate from their plan, they will write down their rationale.

As Nobel laureate Daniel Kahnemann explained in his book “Thinking, Fast and Slow” (Farrar Strauss and Giroux, 2011), people don't want to cede all power to the quick-twitch intuitive parts of their brain.

Slowing down and simply writing down why they want to change course triggers more-deliberate, rational thinking.