3 Behavioral Finance Concepts that Can Impact Retirement

When it comes to financial planning, many people benefit from understanding how certain psychological concepts impact their decision making. The truth is that managing your money is one of the most emotional things you’ll ever do. Finances and psychology are inextricably connected. Unfortunately, that sometimes means that individuals are limited by their own behavioral biases. 

Being cognizant of what biases may be influencing your financial decisions can help you to set yourself up for success in retirement. Let’s review three common behavioral biases, and how they impact your financial plan.

#1: Hyperbolic Discounting

Hyperbolic discounting is the behavioral tendency for people to choose a smaller reward that will be delivered sooner, rather than a larger reward that would be delivered later on. In life, this can show up as blowing your diet out of the water by binge-eating junk food because the satisfying “reward” is too good to pass up in the moment - even if the long-term reward of better health is much greater. 

In retirement, this can show up in several ways:

  1. Taking much larger withdrawals from retirement accounts (like a 401(k)) at the start of retirement without accounting for needing the funds later in life for unexpected expenses like long term care.
  2. Jumping at a lump-sum option from an available pension without a plan for the funds, rather than selecting a payment plan that could provide ongoing income for your spouse or partner after you pass away.

#2: Herd Mentality

It can be challenging to stick to your retirement plan when you hear of multiple friends or family members who are doing something different. It’s all too common to see what other investors are doing with their portfolio and to follow suit. 

This could mean selling many of your investments when the market is down or choosing to buy a notable amount of one particular company’s stock because someone you know did the same and saw notable gains. It’s key to remember that what works for one person won’t work for everyone. Although it’s easy to see someone you know, trust, or respect is succeeding with a particular strategy and want to emulate it, you have to remember that your goals and investment timeline is different than theirs. 

#3: Loss Aversion

Many pre-retirees and retirees have a low tolerance for risk - and with good reason! When you are nearing retirement, you need your funds to continue to grow or to maintain value since you will be using them soon. However, the natural aversion to loss that all people feel can negatively impact your financial decisions as you near retirement. For example, many pre-retirees or retirees choose to go to all cash for fear of losing any value in their portfolio. However, going to all-cash could result in them losing to inflation and future gains that can assist in expenses associated with aging, and leaving a legacy. 

Safeguarding Your Retirement

At the end of the day, it’s important to remember that your retirement goals are completely unique. Falling into a behavioral finance trap can potentially lead you to make decisions that, while emotionally comfortable, aren’t always in your best interest. Working with a third-party advisor can help you to take a more objective approach to your financial plan, helping to safeguard your retirement. 

Interested in learning more? Reach out! We’d love to speak with you.

Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs, and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. We can be reached by clicking here.

"Finance Made Simple" blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.

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