Saving for retirement: overcoming optimism bias and decision fatigue

Do you overestimate the probability of your success? Chances are yes, because of what’s termed ‘optimism bias’. This bias refers to our tendency to overestimate our likelihood of experiencing positive events and underestimate our likelihood of experiencing negative events.

Of course, it’s necessary to have some optimism. Optimism encourages us to take risk or to persevere – even in the face of hardship or rejection. But it’s important to be aware of how our optimism can blind us to negative outcomes. It’s a combination of optimism bias and decision fatigue which often causes people to postpone saving money for retirement and ultimately not have enough and be forced to work longer.

“Optimism is normal, but some fortunate people are more optimistic than the rest of us. If you are generally endowed with an optimistic bias, you hardly need to be told that you’re a lucky person – you already feel fortunate.”

— Daniel Kahneman, psychologist and economist

Why people don’t have enough for retirement

It’s not that people don’t have a sense of urgency about saving for their retirement. Many aspire to save for the future and most understand the responsibility that comes with it. However, it doesn’t always translate into action.

There are several reasons why someone might not have enough for retirement. And it isn’t necessarily down to their level of income. I can be down to their knowledge and motivation to save. For many, setting a clear target is really hard. Although we understand that people retire when they turn 66, the reality is more complicated. For one, people are living for longer.

After they retire, some people tend to increase their spending either through traveling or simply indulging in all the hobbies and interests they dreamed about for the last 40 years while sitting behind a desk. Some downsize significantly without kids at home – and may find their spending falls dramatically. All these factors mean it’s hard to accurately plan for retirement. In other words, there is no “magic number” or specific target to aim for.

Saving in general is always problematic as abstract goals are often the most difficult for our brains to pursue. Retirement fits right into this category. I for one can’t imagine retirement but I know, in the abstract, I’ll need some amount of money for however I choose to spend my time. Where retirement savings are concerned, without “the number” to aim at, the pursuit is hampered by many.

Often, when people make a budget or even list their financial goals, they focus on the nearer-term, more specific goals. Those in their 30s may focus on saving for a down-payment on a house, those in their 40s may prioritise their family and children’s education. In your 50s you may look towards more discretionary purchases like holidays or maybe even a second home. But when all these other things take precedence, they just push retirement further and further back on the agenda.

How to get your retirement back on track

Many of us don’t understand the importance of exponential growth, or compounding. Psychologists have found that our default understanding of problem solving is linear in nature. This means that we associate our savings in a linear fashion, thus actually underestimating how much our savings could be worth in the future. The result of this underestimation is that it has a negative impact on our motivation to save now.

But as Albert Einstein once said, compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t pays it.

Here is an example of how it works: In the first year I invest £1000. It grows by 5% and at the end of the year I have £1,050. The next year my pot of money grows by 5% again. At the end of that year, I don’t have £1,100 as our brains may initially think – I have £1,102.50 because my interest from the previous year has grown too. Over many years, compounding can make a huge difference to our retirement savings.

Still dithering about getting started? I’m not surprised. After all, if we can’t even make a decision about dinner, how are we meant to make decisions that could impact our future so greatly? To alleviate this pressure, a multi-asset fund might be an option. Multi-asset funds typically offer you a wide range of shares, bonds, property and other types of investment from various geographies, in one simple product. This helps with diversification and takes very little effort – all you have to do is pick a fund and an expert manager makes the rest of the decisions for you.

You can find all our Elite Rated and Radar multi-asset funds here, and the top five performers this year are listed below.

The top five performing Elite Rated multi-asset funds in 2021*

Fund NamePerformance
Jupiter Merlin Growth Portfolio15.84%
Premier Miton Diversified Growth14.84%
TB Wise Multi-Asset Growth14.39%
Jupiter Merlin Balanced Portfolio12.89%
Liontrust Sustainable Future Managed11.86%

*Source: FE fundinfo, total returns in sterling, 1 Jan 2021 to 28 Nov 2021

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.