4 Reasons Why People Underestimate Their Retirement Savings Need

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DBS survey of 800 people in 2014 showed that:

  • 73 per cent of the people polled plan to retire between 55 and 65, with an average savings of $571,715.
  • At the same time, more than 85 per cent of those polled expect to live on a retirement income of $3,500 per month for the next 15 to 20 years and more.
  • However, there is a big gap between both sets of numbers as the average retirement savings amount would only last 13 years and not 15 to 20 years.

These statistics are worrying but fret not! The rest of this article explains the 4 reasons people underestimate how much retirement savings they need, which will give you greater clarity in planning for your future.

1. Length of retirement

Two things determine our length of retirement – life expectancy and retirement age. According to Department of Statistics Singapore, our life expectancy is 83 years. This means that if you desire to retire by age 60, your savings will need to last for 23 years. This is a huge 10 years difference with DBS’s survey findings!

However, when you actually retire might vary as many people choose to work part-time even after they stop full employment. For instance, many retirees become private tutors or piano teachers, or work part-time in their professions as consultants.

2. Not adjusting for inflation

It is important to note that the final sum you will actually need depends on when you will retire and the actual figure you will need to save because of inflation. Let’s say you desire to retire 30 years from now and will need to spend $3,500 monthly in today’s dollars, assuming an average inflation rate of 3%, your monthly expenses will grow to $8,500 in 30 years’ time.

On the other hand, if you’re planning to retire tomorrow, you won’t need that much as expenses today are definitely much less than they’ll be in a few decades’ time.

3. Overestimating investment returns

Some people belong to the group of more aggressive investors. Being human, they may tend to have optimism bias in terms of investing. Since your stocks have been performing well on the market over the past few years, you start to expect to enjoy a steady 5% return per year for the rest of your life. And everyone just assumes that property values will accrue over time, never mind that there’s a downtrend in the property market now.

When estimating your investment returns, it is best to project modest gains or you would risk getting a rude shock when you investments do not perform as well as expected and you have to delay your retirement plans.

4. Not accounting realistically for discretionary expenses

We may be able to survive on a few hundred dollars a month by eating bread and drinking water every day. But I’m sure nobody would think of living life like that when calculating how much we need to retire. Other than healthcare expenses and insurances, you might also want to spend on things like travel, stuff for your kids or grandchildren, your hobbies or simply the finer things in life. As much as you want to retire as early as possible, you have to be realistic about your spending.

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Is Paying for Insurance a Gamble? Your Biases Could Hurt Your Finances

 Some people may feel that paying for insurance and gambling are similar because in both cases, a person sets aside a smaller amount of money in the hope of getting a disproportionately larger return. Let’s look at the 3 behavioural biases in gambling psychology which could affect your insurance planning – framing effect, loss aversion and optimism bias.

1. Framing effect

The most significant bias experienced by us is that of the framing effect of insurance pay-outs. In gambling, the benefit is the immediate gain of the money wagered. One can immediately experience the joy of winning.

Insurance, on the contrary, has benefits which are not easily foreseen. Is it an asset or a liability? Why should I be paying money to cover an event that I do not wish would happen? Decision making behind insurance purchases is in direct conflict with many of our common product purchases. Would I buy a computer and not use it? This bias is stronger towards insurance due to its benefits being intangible. When a product is too complex, we tend to procrastinate decision-making and thus, insurance is often neglected among our priorities.

2. Loss Aversion

Humans are highly loss averse.  We have a stronger tendency to avoid losses than to acquire gains. Empirical estimates that from a gambling perspective, the pain of losing $100 is at least twice the joy of gaining $100. So, if people are more loss averse, does that mean people are more likely to buy life insurance? The purpose of insurance is to protect us and our family against huge financial losses from catastrophic events right?

Unfortunately, the thought process of a consumer on the street is even simpler than that and the following video is indeed a cause for concern.

A probable reason for this finding would be that people view paying insurance premiums as a guaranteed loss, while the insured event is just a possible loss. When one is faced with a small guaranteed loss versus a larger possible loss, as behavioural studies suggest, many will choose to take a gamble and NOT buy any/sufficient insurance. Many people risk having their savings wiped out and find themselves severely lacking in insurance coverage ONLY when disaster strikes.

3. Optimism Bias

This is a well-established bias that causes someone to believe that they are less at risk of experiencing a negative event compared to others. Will a gambler walk into a casino thinking he is going to lose money? The answer is almost definitely no as we are often filled with high hopes of making a profit.

On hindsight however, many gamblers will feel that they should not have started gambling in the first place. Unfortunately, this realization usually comes only after one has suffered a significant loss. Optimism bias always leads one to overestimate the chances of winning and underestimate the risks of losing.

The same logic applies for insurance. Most people feel they will certainly live a healthy and accident-free life. (Honestly, who doesn’t?) Sadly, life is as predictable as the September 11 attacks and we can’t use a crystal ball to find out what happens tomorrow.

Insurance planning is an integral part of one’s financial plan. In the event of a thunderstorm, only those who carry an umbrella can be sheltered. People who don’t have an umbrella end up drenched. A well-planned insurance portfolio is the exact opposite of a gamble. Without sufficient coverage, we are gambling with the financial future of ourselves and our loved ones. Given the little insurance planning most Singaporeans have, many people may be “gambling” without realizing it.