Being aware of our behavioural biases could mean a significant increase in retirement savings. There are two common biases that can affect how we save for retirement:
1. Present bias – the tendency to put more value in current or short-term decisions than the future
2. Exponential-growth bias (EGB) – the tendency to underestimate and neglect the power of compounding investment returns.
A person with present-bias may intend to save more in the future but never do so; while a person with EGB will underestimate the returns to savings and the costs of holding debt.
All is not lost, however, as understanding your own biases is the first step to creating a proper retirement savings plan to fund the lifestyle you want when you stop working.
Self-awareness has the potential to reduce the impact of our biases. For example, a person who is aware of his/her EGB could rely on the market to acquire tools or seek advice, and a present-biased person could use committed arrangements to control the impulses of his/her future self.
It is proven that people who understand their EGB, hence accurately perceived the power of compounding, had about 20% more savings than those who neglect compounding completely.
So what does this mean? Be aware and keep check of your biases, and your retirement nest egg could be a lot bigger.