Why do we sometimes make decisions
that are not in our best interests?
One behavioral finance theory says this happens when the speed vs. accuracy tradeoff in our brains creates a gap between “what I should do” and “what I actually do.”1 And this gap can lead to costly mistakes and behavioral blind spots in our financial planning.
Let’s explore 3 common blind spots and how to counter them.
Planning fallacy
Overestimating the likelihood of positive future events and underestimating the likelihood of negative future events
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Anchoring bias
Relying on the first information we receive, or too much pre-existing information, when making decisions
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Mental accounting
Mentally organizing money into buckets allocated for specific purposes — but not allowing reasonable deviations from this approach
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The brain doesn’t like logical, rational, conscious thinking — and will take any shortcut it can.2
1 SUE Behavioral Design, "Kahneman Fast And Slow Thinking Explained," 2022.
2 Digital Enterprise Show, "Two Ways to Increase Engagement and Response Using Behavioral Science," July 18, 2019.
Planning fallacy occurs when we make decisions based on limited, imperfect information.
For example, many people say they plan to retire at a later age than they actually do. Research by the Society of Actuaries found that while 72% of people plan to work to age 65 or later, in reality only 24% work beyond the age of 64.1
As far as reasons for the disparity, health issues and layoffs are cited 60% of the time as leading to an early retirement.2 Interestingly, we often have little control over those issues and rarely prepare for them.
Planning fallacy bias can trick you into making decisions and choices that are more optimistic than factually/data based. Because there’s so much outside of your control, it’s easy to focus on what you think should happen and fail to consider the risks that can come with certain major life decisions.
Shine a light on your planning fallacies.
Rely on data from people in similar circumstances.
Rather than asking, “What is the right age to retire?” it might better to ask, “At what age have others in similar circumstances retired?” Start with the average experience and adjust up or down from there based on your unique situation.
Conduct a premortem.
Ask, “What could take this plan off track?” You have to be a pessimist and fight against your natural optimism to uncover the biggest threats to a retirement plan. This can lead to some uncomfortable conversations around what happens if someone loses their job or finds themselves in poor health. But addressing challenging issues up front can help you plan for the unexpected.
Get an unbiased gut check of your plan.
Talk to your financial professional who works every day with clients like you, many of whom may face the same decisions you face with your retirement plan. Your financial professional has seen what happens along the path to retirement and may be your best source of an unbiased perspective.
1 Society of Actuaries, “2019 Risks and Process of Retirement Survey,” May 2020.
2 Ibid
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Anchoring bias shows us the first piece of information we receive is often the most influential.
A good example of this is related to the decision about when to claim Social Security benefits. Because 62 is the youngest age someone is eligible to begin receiving retirement benefits, it is often the first number we consider. In this case, 62 becomes the anchor.
Retirees often cite health issues or job losses as reasons for retiring early. And when forced out of the workplace, many people look for income from any source they can find. But Social Security isn’t always the best place to get it. For example, many investors could afford to delay claiming Social Security even a couple of years if they tapped their Individual Retirement Account (IRA) first. However, 57% claim Social Security before they take distributions from their IRAs.1
The point is that in most instances, individuals who claim early are reducing their future benefit significantly. And anchoring bias may be at least partly to blame.
Don’t let anchoring bias weigh you down.
Acknowledge anchoring bias.
The next time you are making a financial decision, ask yourself if there is existing information that could be influencing you.
Delay your decision.
The brain is optimized for speed, which can lead to inaccurate or bad choices. Purposefully slowing things down can help. Remember, there is a speed vs. accuracy tradeoff that creates a costly gap between “what I should do” and “what I actually do.”
Educate yourself.
Knowing the powerful effect strategic anchors can have on your judgment can help you counter their impact.
1 NBER, "The Financial Feasibility of Delaying Social Security: Evidence from Administrative Tax Data,” September 2015.
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Mental accounting can be a problem if it makes us afraid to spend money in retirement.
According to behavioral economist and Nobel Prize winner Richard Thaler, many people mentally divide their assets into buckets set aside for specific purposes.1 For example, they reserve portions of their paychecks for various savings goals and another portion for everyday expenses.
Sounds logical, right? But here’s an example of how mental accounting can become a blind spot. Some people dutifully contribute money every month to a low-interest-bearing savings account while at the same time running up a large credit card balance at a high interest rate.
Mental accounting can also be an issue in retirement. Many retirees say it’s more important to feel financially secure, so they treat their savings as “untouchable.”2 But while the desire to conserve and not overspend is admirable, retirees may miss the joy of spending money they can afford on new experiences or charitable causes.
Don’t overthink the mental accounting bias.
Treat all assets equally.
At any stage of life, it’s a good idea to treat all money as having the same value and importance, regardless of how it is being used.
Focus on cash flow.
In retirement, building an investment portfolio designed to generate cash flow may be another way to mitigate this bias because spending income (rather than assets) is preferred by so many retirees.
Find sources of guaranteed income.
You may also want to consider financial products (such as annuities) created to produce predictable income. Talk with a financial professional to learn more.
1 Journal of Behavioral Decision Making, “Mental Accounting Matters,” 1999.
2 Blackrock, “To spend or not to spend?” January 2022.
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Annuities are long-term, tax-deferred vehicles designed for retirement. Variable annuities involve investment risks and may lose value. Earnings are taxable as ordinary income when distributed. Individuals may be subject to a 10% additional tax for withdrawals before age 59½ unless an exception to the tax is met.