Summer Article Series: Retirement - Burying Bias (Article 2 of 3)

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My dog, Rudy, loves getting a new rawhide chew – which he will play with for about five minutes before promptly burying in the backyard. He has buried countless things – all to my wife's dismay when she looks at the little holes scattered about. Rudy occasionally finds and digs up what he buried and then prances around with his now dirty treasure like he is the luckiest dog in the world. Rudy's "saving mentality" reminds me of a lot of people I know (including myself). We have all been told to "save for a rainy day" or "save for retirement" and many of us become excellent savers. I hope that by working with me, many of you have improved as savers as well.

We save and accumulate wealth to prepare for retirement. Once we retire, however, the assumption flips that we will then shift from saving to spending our retirement assets. Studie¹ show, however, that most retirees are reluctant to spend their retirement principal and instead reduce their spending to match their income from dividends, interest, or other earnings (Social Security, pensions, etc.). In low interest rate environments like we have today, this can make for unnecessarily frugal living.

The reluctance of retirees to spend their wealth in retirement may be explained through the lens of behavioral bias – a tendency to think or act in a certain way. These tendencies can lead us to make irrational decisions in investing. Here are some common behavioral biases that could affect your lifestyle when it comes time to retire.

Familiarity Bias: This is the preference for what we know and are comfortable with. I believe this is the biggest factor in people being resistant to change. Retirees often accumulate their retirement assets by working for many years and consistently spending less than they make. When they retire, the mental shift to spending down their wealth and assets is unfamiliar and uncomfortable.
Loss Aversion: When people prefer to avoid losses over acquiring gains, they are exhibiting loss aversion. Simply put, it feels worse to lose $10 than it feels good to make $20. One study² found that retirees were up to five times more loss averse than the average person. Retirees may view their wealth decumulation as "loss" of principal and instead try to get by on dividends, interest, and other earnings rather than selling something from their portfolio.
Endowment Effect: We tend to value things that we own over things we don't and this tendency can lead to the overvaluation of our possessions. Have you ever wondered why someone wanted to sell something they owned (a house, car, etc.), but were asking far more than fair market value? It may be because of the endowment effect. When it comes to retirement, this bias may make retirees feel more attached to their retirement assets and therefore reluctant to spend them.
Declinism: This is the tendency to see the past as better than it was and the future as worse than it will likely be. Retirees who are affected by this bias may be less likely to spend retirement savings to ensure that they are prepared for what they see as a pessimistic future. By holding on to their assets, they feel more protected.

Everyone is susceptible to bias but recognizing and discussing these biases can help us make better, more conscious decisions. If you are retired or nearing retirement, you may want to consider which biases might be hindering you from living the lifestyle you worked hard to achieve. As always, I am happy to act as a sounding board as you reflect on your biases. In the meantime, if you have any tips for getting Rudy to stop digging holes, I'm all ears.

In next month's article (the final one in the summer retirement article series), I will discuss the complexities of something called wealth decumulation. I don't have another Rudy story, so I'll upgrade and share an observation from my wife.

If you have questions or if you would like to discuss retirement spending with me, you can e-mail me at mhaertzen@wtwealthmanagement.com or call (520) 204-1058.

Sincerely,

Matt Haertzen, CFA, CFP

References:

Taylor, Todd, et al. "The Decumulation Paradox: Why Are Retirees Not Spending More?" Investments & Wealth Monitor, 2018, pp. 40-52.
Johnson, Eric. 2010. Hyper-Loss Aversion: Retirees Show Extremely High Sensitivity to Loss, but Shy Away from Guarantees That Require Giving Up Control. In Shlomo Benartzi, "Behavioral Finance and the Post-Retirement Crisis." Allianz Global Investors: 8.

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