Rewire Your Brain, Save for Retirement

by | Feb 21, 2011 | Healthy Money Relationships, Weekly Column | 1 comment

Do you need motivation to help you save for retirement? Here’s a suggestion: try living for a month on nothing but your projected Social Security check.

The reason this might work lies within the human brain. There’s a big difference between what we know and what we do. Most of us intellectually “understand” that someday we’ll be unable to work and will need to survive on an income based on what we “did” rather than what we “do.” Most of us “understand” that Social Security and welfare programs provide for only a Spartan existence.

Yet, 68% of Americans say they haven’t saved enough for retirement and struggle to change this self-destructive behavior. And that’s just the ones willing to admit the truth.

Researchers have long searched for a psychological explanation as to why humans often behave so irrationally. What we know is that saving for retirement is similar to exercising, dieting, or quitting smoking. All these activities offer future benefits rather than immediate gratification. Such a value proposition doesn’t sell well to the human brain, which is wired for “now.”

There is some evidence that humans act more rationally when decisions are in the future. One study gave participants the option to wait 100 days to receive $100 or wait 101 days and receive $101. Most participants would wait the one extra day for the extra buck, which actually represented an annualized return of 350%. But when given the option to take $100 now or wait until tomorrow and receive $101, the majority took the money now, clearly an irrational financial decision.

The study of behavioral finance calls this “hyperbolic discounting,” where people place a lower value on future benefits and overvalue the present. This tendency is exceptionally problematic when it comes to saving for future goals like retirement. We tend to over-consume and under-save until retirement becomes a present reality. By then, of course, it’s too late.

In the past, finance professionals have criticized those who behave irrationally as being “lazy,” “ignorant,” or “undisciplined.” While certainly a person who is not saving for retirement exhibits a lack of self-control, the reason may be in the construction and evolution of the human brain rather than a willful defiance of rationality.

Our brain consists of an older brain, the limbic system, which is overlaid by a newer brain, the cerebral cortex. The limbic system is the source of emotional decision-making, while the newer brain processes reasoning and conceptual thinking.

The emotional processing of the limbic system involves measuring and assessing risk. In a study called Pension Design and Structure, Mitchel and Utkus found two components of risk: “Dread risk,” which is the potential for catastrophe, and “Uncertainty risk,” which is a generalized fear of the unknown. When most people consider retirement, neither of these fears is likely to be strongly felt.

Researchers tell us 80% of all decisions are made emotionally, in the limbic brain. In order for us to take action and save for retirement, both brains need to become involved in the decision process. We must crank up the limbic system’s sense of risk by bringing the consequences of retiring without enough money from the future into the present.

One way to do this is to make out a budget using only Social Security and any pension income. I find most people resist this exercise in the same manner they resist saving. Some researchers suggest actually living for one month on Social Security income. Experiencing life on an inadequate income could be enough to activate the limbic system’s fear response and convince our brains that saving for retirement is an action well worth taking.

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