At Callan’s recent National Conference, our guest speakers tackled the major issues and themes facing institutional investors in the coming years. We’ll cover the highlights of their comments in a series of posts. This is the third; the first appeared here and the second here.
In a workshop called “Facing the Facts: How Misperceptions About Aging Impact Financial Decisions,” Hal Hershfield, an associate professor at the UCLA Anderson School of Management, and Raphael Schoenle, an associate professor at Brandeis University, discussed their research on this topic and how their insights can help plan sponsors.
Hershfield’s research focuses on a critical question: Why are people so bad at making decisions that put them in a better place in the future? In part, the answer stems from how people perceive their identity over time. People do not have one identity, but a collection of distinct “selves”—different versions of themselves over time. Research indicates people think of future selves as other people.
This is a critical insight because people are self-interested. If their “future selves” seem like other people, taking steps to help them is irrational. And this is a problem.
The counter to this argument, he said, is that people are not always self-interested; they make sacrifices for their children, spouses, etc., all the time. So his idea is to get people to define their future self as a “close” other, not an emotional stranger like “Bob in accounting.” In his research, he found that how connected someone is to their future self is tied to how much in assets they save. The more a future self was a stranger, the more people wanted to spend money today.
Hal Hershfield, left, and Raphael Schoenle
To change this, he said, would require making the future self “more vivid, more emotionally evocative.” One way, he said, was to use age-progressed images to get people to save for the long-term by being able to visualize their future self.
Schoenle’s research focuses on what he called “mortality beliefs.” These beliefs are important because day-to-day planning depends on people’s beliefs of when their lives will end. This also ties into two puzzles about savings and consumption: The young consume too much and save too little for retirement while retirees consume too little and save too much. This is problematic for the retirement industry, which is trying to help retirees run down their assets.
What makes people save? The decision is connected to the belief in one’s lifespan. If people think they’ll be around tomorrow they will save—if not, the rational thing to do would be to throw a big party!
His research focuses on systematic mistakes in survival beliefs that relate to the two puzzles, about how the young and old save and consume. A survey he conducted found that the young underestimate their chances of survival and the old overestimate them. A key belief for retirement is whether we’ll reach old age. Errors about that estimate matter because they affect savings decisions.
The two professors also addressed a handful of questions related to their research and its implications for the institutional investing industry:
What are key misconceptions that millennials have about aging and retirement?
Hershfield answered that one misconception is they think aging and retirement are depressing, when research shows that the well-being of older people is actually pretty good. Well-being dips between ages 45-52 but goes back up. Older people, he said, start focusing on important goals: doing what they want to do.
Schoenle also discussed the factors he said drive the pessimism of the young and the optimism of the old: Their beliefs in the risk of death, which affect their views of survival likelihood. Specifically, he said, the young tend to place too much emphasis on deaths from freak events like shark attacks and less on medical risk factors.
What are the impacts that plan sponsors and the industry should be looking at when it comes to these misperceptions?
Schoenle said that biases in survival beliefs have profound implications for savings and consumption. Sponsors should look at these biases since mortality beliefs affect financial decision-making. Pessimistic people—who think they are less likely to survive than they actually are—spend all their income while optimists save.
Hershfield pointed out that one study found more optimistic people tend to live longer. What can sponsors do? Given the relationship between health and savings behavior, they can learn what their employees’ beliefs of the future are and how those beliefs might feed into their behaviors around savings.
What perceptions do people near retirement have?
Hershfield said people are not good at predicting what they need in retirement, especially near retirement. People think lump sums are worth more than they really are, and that showing them a monthly amount of money in retirement rather than a lump sum may help people save better.
How can sponsors educate young people?
Hershfield said education is not the answer. The solution is to get people to sign up by focusing on their future self. And then get people to save by making it easy and automatic.
Schoenle also recommend raising probability literacy—to understand how to prepare for retirement and how to put different future risks into proportion.
Why are participants not buying annuities?
That’s the “trillion-dollar question,” Hershfield noted. Lack of trust in financial institutions was one reason, he said. Misunderstanding longevity was another. Also, people don’t like thinking about annuities because they don’t like thinking about death. And, he said, annuities should be framed as a useful security mechanism, not as a great investment.
