Want to retire? Your brain could get in the way

The pandemic has been a catalyst for many workers rethinking their retirement plans. Millions decided to retire earlier than they planned because they did not see a way back into the labor market. Millions more are wondering what strategies they should employ to keep their retirement accounts afloat.

You should start by considering the complex machine that makes all your savings decisions: your brain.

Consider this phrase: “Salt and ___.” You arrived at the missing word in an instant. It didn’t require a lot of thought. It was practically unconscious.

It turns out that most of our day-to-day decisions — including how we plan for retirement — happen just like that. We’re almost always on autopilot. We have evolved to avoid taxing our limited mental resources, and for good reason. Too much analysis often leads to “analysis paralysis”, which prevents us from moving forward.

Read more: Not your grandpa’s retirement: How the end-of-work landscape has changed 

In Thinking, Fast and Slow, behavioral scientist Daniel Kahneman describes two thinking systems. System 1 covers fast, instinctive, and automatic thinking, while System 2 handles slower, more deliberative, and more resource-intensive analysis.

Our brains default to System 1 thinking for most of our daily tasks and decisions. We use intuition, gut feelings, rules and heuristics (also known as “decision shortcuts”) so that we can move forward quickly without getting overwhelmed by cognitive load. An example is the heuristic “you get what you pay for”, which helps us avoid wasting money on cheap goods that don’t stand the test of time. While rules like this make our lives easier (and save us a lot of time), they often come at the cost of systematic bias. For example, we often pre-judge less expensive items to be low quality, which is of course not always the case.

A downside of relying on heuristics is that it often causes us to prioritize immediate results. One of the hardest problems we face in our lives is saving for retirement. It requires significant savings to pay for the last quarter of your life. Unfortunately, some of the otherwise helpful mental shortcuts we use in our day-to-day make it hard to focus on what our lives will be like decades down the road. The result is that nearly 80% of Americans are not saving enough for retirement and nearly 50% of Americans are not saving at all.

Here are a few of the important biases that affect how we form our retirement plans and savings habits:

• Present bias: We put less value on future rewards, which makes it hard to incur a small cost today (such as saving money from your paycheck) in exchange for a larger reward in the future (like a retirement nest egg that takes advantage of compound interest).
• Information aversion: We naturally avoid information that we think will be too overwhelming. As a result, one study found that financial education has almost no effect on people’s savings.
• Conformity bias: We often yield to social norms (a.k.a. “social proof”) and conform to what others do and think, even in financial matters. We see people’s spending, but not their savings, which means that we do not take advantage of mirroring others’ good saving habits.  

The good news is that if you’re aware of these biases, you can overcome them and even use them to your advantage as you save for the future.

Read more: For millennials, the pandemic helped kick-start their savings 

So which one of Kahneman’s systems of thinking should we use when it comes to making retirement decisions?Ideally, both! You can leave some decisions in your automatic System 1 basket and farm others out to System 2 with careful analysis, planning and logic. The balance will depend on how much time and interest you have in learning about the intricacies of investing. For most of the general population, automated tools make investing more efficient, accessible, and less stressful.

When biases are made visible and top-of-mind, we can devote time to making small corrections to counteract them. If we recognize our present bias, we may be more willing to incur higher deductions from our paychecks today for better returns tomorrow. If we try to overcome our natural information aversion, we could be more willing to learn about how smart and diversified investment strategies will boost our balance. Rather than troll social media sites, allowing our conformity bias to lure us into spending as much as our friends, we might instead make an effort to divert some of those dollars into a 401(k) account.

When it comes to retirement plans, accepting default settings that are beneficial to savers (System 1 thinking) is often the smartest strategy. To correct for some of our retirement cognitive bias — which might keep us from saving altogether or introduce complexity that ultimately lowers balances — a default setting like a 6% contribution that automatically increases over time makes sense. Research shows us that more people will participate, saving billions of dollars more compared to using no default setting.

Popular media has labeled humans irrational decision-makers. I believe a more accurate way to frame it is that we are built for survival, and the systematic bias embedded in our decision-making sometimes steers us off the course of long-term self-interest. AI, automated investment tools, and the incredible collective computing power we have today are valuable tools to help us defend resources that ensure our survival today and tomorrow, just like the spears those early humans used to fend off or hunt predators. But today we’re using that technology-powered spear to defend against our own cognitive biases and land the biggest nest egg we can.