Dr Susan Thorp talks about why saving for retirement is challenging and how employers can help.
Saving for the future is one of the most important actions someone can take to secure their long-term financial wellbeing. After all, the money people save today is the money they will need to live off for about a quarter of their lives, once they get older and stop working.
Yet for many, and particularly for young employees, saving for retirement can feel too costly when there are other important expenses to pay for. Concepts like investment risk and diversity can also be difficult to grasp.
Earnd spoke to the University of Sydney’s Professor of Finance Dr Susan Thorp, who researches consumer finance with a particular focus on retirement savings, about why it is that many employees struggle to engage with their retirement savings.
Many of us struggle to save for retirement because we have what is known as a ‘present bias’. This is our tendency to focus excessively on the present rather than the future. We plan to do things well, but we don’t execute on those plans because when the time comes to follow through, we decide we would prefer not to. We’ll do something else.
The fundamental psychological reason we find it difficult to save for retirement is because we are disconnected from our future selves. Our future selves are relative strangers to us.
Experiments from behavioural science show that we lack empathy for our future selves. We simply don’t care as much about our future self as we do about our current self. Because we lack empathy for our future self, we aren’t terribly interested in looking after that strange person who is going to exist when we are 60.
There was experimental work done by Daniel Goldstein, a professor of marketing at London Business School, who found if you could simulate ageing for individuals digitally, you could motivate empathy, which helps encourage people to put money aside for the future.
Goldstein had a group of people interact with digitally-aged images of themselves and measured if this impacted how much they were willing to save for retirement. When people were confronted with the fact they were going to age, they were more willing to save than those who didn’t see the digitally-aged avatars.
But what helps people to engage with their retirement savings is not so much the right story, metaphor or information – especially for those who are younger – instead it’s the passive strategies that tend to work in helping people to save for the long-term. A passive strategy is when an employee is automatically enrolled or ‘defaulted’ into a retirement savings program. When someone has been defaulted into a savings program, usually with a portion of their pay going to a savings fund, savings balances usually grow.
That’s why it’s important to pick a fund that is a good performer or to review a decision once it has been made. Unfortunately, the same inertia that helps people to save also prevents them from making active decisions when they are made worse off by the fund.
Another barrier to engaging with our long-term savings is the fact we don’t know if we’ll actually need all this money that we are saving by the time it is available to us. For example, if you’re an Australian and you have 30 years ahead of you before you retire, you might value your retirement savings less simply because you don’t know if you’ll be around by the time that you’re allowed to access it.
There’s also a great deal of uncertainty about how your contributions might work in the future. For example, you don’t know how much you will earn, whether you will be in and out of the workforce or whether you will be earning from a traditional employer at all.
Then there is uncertainty about the regulation of super itself – what will the government do between now and when you can access your money? Will they change the tax rules?
Another aspect to this is that many mathematical concepts associated with retirement savings – such as that of investment risk or compound interest – aren’t easy to grasp. For example, many of us think about our savings growth as linear, rather than exponential. This is why rules of thumb can help when it comes to thinking about retirement savings.
One rule of thumb I often use is: ‘every dollar you don’t contribute to super in your thirties costs you three dollars to make up in your fifties’, but that could be an underestimate.
When we give people projection information of their future balances, we see an almost 30% increase in the amount of contact people make with the fund to get more information.
People do save more when they’re given information about the future that they can understand. That’s partly because you’re overcoming people’s failure to deal with exponential growth. You’re doing it for them, so they can think ‘Maybe I should save more’.
We also found that giving individuals information about their long-term savings as both a lump sum amount and as an income stream – be that a monthly or fortnightly payment – was the most effective way to prompt people to engage with their savings.
It’s also worth keeping in mind that while it is often difficult for people to engage with their retirement savings when they’re young, they aren’t permanently disengaged.
We see that as the stakes get higher – as the amount people have in their retirement fund rises or as they get older and closer to retirement – they do tend to become more engaged with their retirement savings.
But even so, it’s always a good idea to help people understand how their retirement savings are tracking, so they can build them up as and when they can – and be ready to enjoy retirement.