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Sent: 28-04-2009 10:47:01
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When a Negative IMF Forecast is Still GoodEmail Marketing Business Opportunity - Helen BairstowEmotions & Retirement SavingThe Easiest way to do a Client NewsletterFederal Budget: Little time to react - prudent to get in quickly?
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Emotions & Retirement Saving

Click here to buy - A How To Book of SMSF's by Tony Negline
Lester Wills

I discovered how similar the US and Australia has become in terms of their retirement savings approaches and in this context came across an interesting document produced by the ING Institute for Retirement Research in the US (there does not appear to be an Aussie equivalent I am afraid). This document was entitled, Emotion, Behvioural Finance, DC Behaviours and Potential Solutions, except of course behaviour was spelt without the u.

As readers of the ATC Digest will recall from my series on behavioural Finance, cognitive and emotional weaknesses affect everyone. However, traditional finance theory ignores such things as the models are based on the premise that people behave rationally, all of the time. Unfortunately, despite the best intentions of many market participants who try to behave rationally, the result of their decisions often falls short of what a subjective observer would say is the optimal approach. Despite their best intentions, people make mistakes and what's more they usually repeat the same mistake, not just once but time and time again. Such behaviour creates emotional responses which in turn affect cogent thinking and as a result rational decision making is impaired.

Behavioural finance looks at how real people actually behave in a financial setting by applying psychological theory to finance. Proponents argue that people are not always rational but that they always "human" In this way behavioural finance illustrates the irrational behaviour of many investors and demonstrates human fallibility, especially in competitive investment situations. In contrast to modern capital markets theory, which claims that the pursuit of profit is the sole motive for trading, behavioural finance postulates that participants in financial markets have other motives as well.

This is the premise behind the document produced by the ING Institute for Retirement Research. Whilst reflecting the voluntary nature of the US market and talked about participant behaviours, typically the failure to participate in a retirement savings plan, many of the ideas illustrated were useful. It outlines likely reasons/emotions affecting (retirement saving) behaviour and then offers potential solutions. It is not earth shattering but just good old common sense, the sort of thing we all know we should do but somehow, sometimes just forget to follow trough on. I have editied the examples below to make them more relevant to Australia:

Reasons/Emotions Affecting Behaviour

Perception of affordability, immediacy... more pressing demands on income; mental compartmentalization of financial decisions.

Potential Solution

Communication (an ongoing process), not education (point in time)... a robust, multi-tiered approach to building participant empowerment about their own futures and making them feel good about participation decisions. This is further explained suggesting that this is all about empowering people with easier, intuitive and meaningful exploration of their options; making it simple to take actions and make appropriate decisions. Given the Choice environment in Australia, sounds like a good approach.

Reasons/Emotions Affecting Behaviour

Procrastination... good intentions but failure to act; retirement may be a long way away.

Potential Solution

Automatic contribution increases... tying incremental increases in contribution percentages to salary increase cycles. Sounds simple but it has been shown to be very effective.

Reasons/Emotions Affecting Behaviour

Understanding... failure to grasp the benefits saving for retirement, especially early, i.e., compounding of assets.

Potential Solution

Target-date or lifecycle funds. The argument they make is that Lifecycle funds can make investment decisions intuitive for people who would otherwise either choose the most conservative investment path, attempt to market-time, or choose not to invest at all because it's just so complicated. The problem is of course that such funds make the investment more and more conservative as a person approaches their target retirement date. But, the process is likely to start again with a new long time horizon as they may be retired for 10, 15 or 20 years. I must admit to having mixed feelings about such things, but given that the alternative is that many people will sit in cash based or ultra conservative funds for long periods...

Reasons/Emotions Affecting Behaviour

Information overload and analysis paralysis... too many decisions to make, too many options to choose from and too confusing; it's easier to do nothing.

Potential Solution

Fund selection... not so many available options to overwhelm participants with complex allocation models and decisions, and not so few as to impede adequate diversification. All sorts of research has found that people get overwhelmed by too much choice and the decision making process shuts down so make things simple and easy for them but taking care not to do things for them (i.e. guide rather than take over.)

A number of the other ideas are very US centric but I provide a link to the full two page PDF document is below in case any one wishes to read the full document.

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