While the recent bear markets that equities have experienced during and after the financial crisis have certainly not helped to lift the values of the portfolios held in retirement accounts, a recent Bloomberg opinion piece argues that the way humans are inherently wired is a bigger problem.
Immediate Gratification
Rick Kahler, who is a certified financial planner based in Rapid City, South Dakota, told the news source that people are essentially programmed for “financial defeat.” He said that people have a tendency to choose whatever option is the most emotionally appealing at the time.
He uses an example of putting $5,000 into a trip to the Bahamas or putting that money into an individual retirement account so that it can be withdrawn for a retirement that is 10, 20 or 30 years down the line, according to the media outlet.
William Meyer, founder and managing principal of investment research firm Social Security Solutions, emphasized the costs that can be generated by the desire for immediate gratification, the news source reports.
The market expert noted that more-than two-thirds of people who claim Social Security benefits decide to claim these benefits at an age as low as 62, according to the media outlet. Married couples might end up losing up to $100,000 as a result of taking these benefits early.
He added that “if you wait to claim until age 70, you’re locking in a benefit that is 76 percent larger.”
More effective retirement planning
There are various ways that investors can overcome their natural wiring and therefore do a better job of planning for retirement. One potential problem that people can overcome is a tendency to buy securities when they are highly-visible and also experiencing high prices, and also sell these financial instruments when they have lost substantial value.
This problem can be overcome by utilizing the strategy of dollar cost averaging, which involves investing the same amount on a regular basis. This is the opposite of making efforts to time the market.
Diversification
Many people also have a tendency to make an effort to pick out stocks that outperform the market. In a market with high correlations, attempting to do so frequently results in failure. Instead, people can diversify their investment portfolios in order to control volatility. Diversification is a strategy that involves picking securities that have the lowest correlation possible.
This opinion piece was released shortly after a recent U.S. Securities and Exchange Commission survey revealed that a substantial fraction of retail or everyday investors know very little about basic financial instruments such as stocks or bonds.