Fooling Ourselves

by | Jun 22, 2009 | Cash Flow, Life Aspiration Planning, Weekly Column

fool.jpgDo you work more than 40 hours a week? Do you have enough money for retirement? Do you wash your hands after you use a public bathroom?

Yes, these three questions do have something in common. They’re all related to the difference between what we say we do and what we actually do. Let’s start with hand-washing. According to Steven D. Levitt and Stephen J. Dubner, authors of Freakonomics, 75% of men surveyed said they washed their hands after using the bathroom. However, researchers who camped out for hours in a number of men’s restrooms found only 10% of men actually washed their hands.

Our tendency to overestimate isn’t limited to just bathroom hygiene. In a Wall Street Journal article on May 29, 2009, Laura Vanderkam suggested that Americans have a bad habit of overestimating how many hours a week they work. A number of studies and books have championed the notion that Americans are overworked, with the 60-hour work week being the new 40. The problem, according to Vanderkam, is that most of the information on these increasing work hours comes from asking people. Given our tendency to overestimate, this may not be the best way to obtain data.

Researchers at the Bureau of Labor Statistics conducted a study that required people to keep a time diary of various activities. They then compared their results with other popular surveys. What they found was interesting. People who said they worked 40 to 44 hours a week actually worked an average of 36 hours. People claiming to work 60 to 64 hours a week actually averaged 44. Those claiming to work 65 to 75 hours a bureau-of-labor-statistics.jpgweek ended up working 55. Based on this information, you can probably just subtract 20% from the number of hours people say they work to get the actual number.

The fact that people overestimate is nothing new to the field of behavioral finance. Researchers have found in study after study that people are overconfident when it comes to their financial and investment acumen. I see this all the time. Of all the investors I’ve ever spoken with, most think they understand portfolio diversification. I can count on two hands those who actually did.

Another instance of overconfidence is how people view their retirement. Most people are unaware they have grossly underestimated the money they will need to maintain their current standard of living in retirement. They are confident that when they retire, “things will work out,” even though the average baby boomer has only $50,000 saved in a retirement account.

What do they expect to do for income in retirement? Most, about 81%, say they will simply continue to work after age 65. However, what people actually do after age 65 is quite different. A 2005 Department of Labor survey found that only 19% of people over age 65 who wanted to work were actually working. The other 81%- either could not find employment or couldn’t work because of health reasons.

You don’t need a formal survey to figure out that people overestimate. Just find any child learning to play a musical instrument. Ask the kid to practice for a half-hour. Then clandestinely set a timer. When the child finishes, ask her how long she practiced. What she says and what the timer says are often two very different numbers.

girl-playing-flute.jpgDeceiving ourselves about hand-washing habits or practicing the flute probably doesn’t matter very much. Deceiving ourselves about retirement savings, however, can have serious consequences. An important part of preparing for retirement may be learning to overcome our own overconfidence.

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