For many Canadians, their golden years of retirement may end up being more tarnished than gleaming.
The average household in Canada socks away only a few thousand dollars each year, and a quarter of all households spend more than they earn, according to a recent Statistics Canada report. These facts amplify findings from the 2016 Canadian census and results of a recent CIBC poll, both of which show that about one-third of all Canadians have no retirement savings outside of government- and employer-sponsored pension plans.
Why are people’s efforts when it comes to saving for the future so inadequate? Psychology sheds some light.
A key feature of human nature is “present bias,” or the tendency to prefer cash flows received sooner more strongly than larger amounts that would be received in the future. That tendency can translate easily into spending instead of saving because present bias introduces a fundamental conflict between someone’s current desires and future needs, with current desires typically winning the battle.
Various interventions are available to override this natural wiring. For example, an important safeguard is already in place for Canadians through automatic participation in the Canada Pension Plan (CPP). However, CPP benefits are likely to fall short of most people’s future needs.
Financial advisors can help clients better navigate the path toward a comfortable retirement in a variety of ways.
One helpful method is to build in automatic savings increases over time. For example, every time a client is scheduled to get a raise to her salary, contributions toward her retirement ought to be increased in lockstep. Professors Shlomo Benartzi and Richard Thaler popularized this method in the United States with their Save More Tomorrow retirement plan.
People find this approach to be appealing because their disposable income doesn’t decline over time, even though their savings rate increases. By making the escalation process as automatic as possible, advisors can exploit the human characteristic of “status quo bias,” which is based on the fact that most of us tend to be too lazy to deviate from the default action.
More creative approaches to help clients enhance their savings are also available. Researchers Hal Hershfield, Elliott Wimmer and Brian Knutson used functional magnetic resonance imaging of the brain to determine that when someone thinks about herself in the distant future – for example, in retirement – her neural activation tends to be similar to when she thinks about a stranger. That is, most people lack a sense of connection with the future version of themselves, for whom they need to make financial sacrifices today. The researchers found that the more connected the person feels with her “future self,” the better equipped she is to overcome present bias.
Strengthening a client’s sense of camaraderie with herself in retirement may help her plan better for the future. Indeed, Professor Hershfield and several co-authors found that people who were shown digitally aged photos of themselves became better able to overcome present bias.
An advisor who is not up for manufacturing wrinkles using Photoshop might instead explore other ways to strengthen the connection between a client’s present and future selves. Possibilities include having a client write a letter from her future self to her present self, or having her detail a typical day from the retirement she envisions.
Clients are human, and with human nature comes a predisposition to consume too many of our resources now at the expense of our future needs. By using these simple strategies, advisors can help clients balance their financial necessities over time.
Lisa Kramer is professor of finance at the University of Toronto, where she conducts research and teaches on the topic of behavioural finance. You can follow her on Twitter: @LisaKramer.