Thinking about your retirement requires looking far ahead into the future. The decisions you make need to be based on solid reasoning, not gut instinct. Yet even your retirement planning can be affected by emotions or incomplete information. Read our five-part series to better understand yourself and your own behavior.
Economists have long assumed that people generally make rational decisions. Not just when it comes to taking out insurance, choosing health cover or buying a car, but especially when purchasing their own home or planning their retirement. After all, such situations require the use of finite resources as efficiently as possible to achieve the best possible outcome.
To what extent was your last financial decision influenced by your emotions?
The observation that people sometimes make very important decisions in an irrational way led to the emergence of behavioral economics in the second half of the 20th century. It was discovered that irrational decisions are common and are based on behavioral biases, which are either emotional or a consequence of incorrect or incomplete information.
Counteracting these biases
Emotional behavioral tendencies can be very spontaneous. They are based on “gut feelings,” which are, in turn, influenced by our environment and education. Though this makes these tendencies difficult to eliminate, they can be minimized to some extent if we become more aware of them. Doing so allows us to mitigate their negative effects.
Cognitive behavioral tendencies, on the other hand, are due to incorrectly or selectively processed information, or to prejudices. They are easier to address than emotional behavioral tendencies and can often be overcome with the necessary knowledge and rational arguments.
Rational retirement planning
The foundation for financial security in old age needs to be laid early, as it will require a period of several decades to achieve. Decisions influenced by unconscious behavioral tendencies can have serious, long-term financial consequences. This is because strategic errors can be perpetuated from year to year, thus reducing financial success.
If everyone made financial decisions on mainly rational grounds, we would all start planning for retirement at the start of our working lives.