2 Investing Biases that Hurt Your Retirement Savings

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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.

Why We Shouldn’t be Bothered with Fear-Mongers

bad-economic-headlinesThere is much fearmongering in the different media which we are exposed to everyday. Take a look at the money section of any website, newspaper or magazine and you will find stories warning you about the Chinese economy, the Federal Reserve’s interest rate policies, the impact of the U.S. presidential election, global oil markets and market volatility.

But none of these stories—while interesting to read and think about—is worthy of spending too much of your brainpower.

Why? Because these big global factors are beyond your control and will be resolved without the slightest help from you.

You cannot control how the S&P 500 will perform or whether the European region will restart pumping profits. History has shown us that there are times when the U.S. markets outperform foreign markets and when the opposite is true. This is also true when it comes to growth stocks, value stocks, small and large companies. There is no way to successfully or consistently predict what will happen next.

So why do we bother?

Psychologists call it the “illusion of control“. Our intellectual minds tell us we can figure it out, even when—trust me—we can’t!

Putting your precious time into what you CAN control is really the only sensible way to go.

Here are six actions where focusing your energies in will reap you rewards:

  1. Develop rational goals built on your values. Let’s face it, without a real plan, you have decided to drift and hope for the best.
  1. Consider possible life transitions and how they might impact your actions. Transitions rarely give notice, so considering the impact of possibilities allows you to put solutions in place.
  1. Build agreement with other stakeholders (your spouse, a partner) on strategies to reach your goals. With all parties working toward the same goals, you’re more likely to be working for each other and get things accomplished.
  1. Invest time and resources to work with professionals who can help move your goals forward. Whether it’s creating a retirement plan or a proper risk management plan, you’ll benefit from working with experienced experts.
  1. Know your financial numbers and assign priorities for savings, accumulation and spending. Consider a rating system from 1 to 5, where you assign a point system to where your paycheck and resources go.
  1. Understand more about the “whys” of your life. Our beliefs don’t just arrive in our thinking like a magician’s trick. On the contrary, your money beliefs—your mindset—come from your money history over the course of your life. And it’s that mindset that determines what you consider the norm. Taking the time to understand whether your beliefs support your values is always time well spent.

These actions are very specific to you—you make the choices, decisions and actions that will support the outcomes you desire.

Devoting time to the economic issues of China or whether equity markets will rise or fall is beyond your ability to control and will only divert your attention from what really impacts your life.

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.

4 Life Stages of Financial Planning

Many of us know that financial planning is a lifelong process. Our ultimate dream is to achieve a retirement life which we desire. This could mean being debt-free, having a passive stream of income and best of all, pursuing our interest and passion which we might not get to do in our younger days.

Our lifelong financial process can be split into 4 stages. What are the crucial aspects which we should consider at each stage? Read on to find out more.

Stage 1: Young Adult (Aged 20-30)

The young adult is new to the working world and naturally earns a low income. He/she is driven to succeed and increase his earning ability. Being single, there are little or no financial commitments for him/her. Some may have an education loan to pay off after graduation which can be fully redeemed after working for 2 to 3 years.

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This is the best time for you to start some form of wealth accumulation to prepare for retirement as it could be harder to save money in later stages of life when financial commitments increase. With the high risk tolerance at a young age, investing in more equities and mutual funds on a regular basis is recommended.

 

Buying a house is common goal for young couples preparing to get married. Do the math on your liquid finances and CPF savings to find out which type of property best suits your financial ability.

Having a comprehensive insurance portfolio is a must as well for wealth protection. Key insurance components include Hospital & Surgical, Critical Illness and Disability.

Stage 2: Young Family (Aged 30-40)

At this stage, one could be married with or without children. With a moderate income, you would have more financial commitments such as a home loan and a car loan. Retirement planning remains an essential component in your portfolio. Risk tolerance starts to moderate as you are one step closer to retirement. A correct investment mix of equity and fixed income helps you to achieve financial goals easily.

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Being a parent, getting insurance cover for your child prevents you from incurring unnecessary huge medical bills. Saving for your child’s future tertiary education should be your concern too. Another wealth protection area concerns the largest debt that you share with your spouse – home loan. If a spouse passes away, any outstanding loan is left to be paid off by the surviving spouse. Be responsible in financially protecting your loved ones in the event of your passing.

 

Stage 3: Mature Family (Aged 40-50)

Your children are grown up by this stage of your life. Your earning ability is at its highest and naturally your expenses increase as well. You could possibly take up a bigger car loan of home loan, thus increasing your financial commitment.

Child’s education and retirement planning are your main financial objectives for the long term. Therefore, your investments should be diversified in equities and debts instruments according to your age, available time and risk ability.

Stage 4: Pre-retirees or Retirees (Aged 50 and above)

retireesBy now, your home loan would have been fully paid off and your children are no longer dependent on you financially. This means low financial commitment which means your protection needs are its lowest stage. However, health insurance continues to play an important role as you age.

The security of your retirement savings carefully accumulated over your younger days, coupled with regular income, becomes your focus now. For that, investments should be more in fixed income which yields regular income with low risk.