Hyperbolic Discounting and Your Retirement Plan

If you often procrastinate, you may suffer from hyperbolic discounting. Adviser Massi De Santis explains what it is, how it impacts your retirement plan, and what you can do about it.
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By Massi De Santis, CFP

Have you noticed how we often make rational choices in our minds when we look ahead, only to ignore that wisdom when we have to make the same choice in the present? We may reason that “In the Spring I will start a new exercise routine or join a gym.” Or, “As soon as I am through with this busy patch at work I will get my finances in order, make a budget, and work on my investments.”

Masso De Santis

Massi De Santis, CFP

However, when the time comes to actually go to the gym, make a budget, or start a financial plan, we find things that are of more immediate importance.

Economists call this behavior hyperbolic discounting or present bias. The priorities of our future selves are different from the priorities in the present. In one experiment, Harvard professor David Laibson showed that when asked to choose between fruit or chocolate a week from today, 74% of the subjects chose fruit. When the subjects were asked to choose between chocolate or fruit, to be consumed today, 70% chose chocolate! The conflict between our current self and our future self is hilariously told in Senfield’s Night Guy Morning Guy joke.

Economic research shows that present bias can explain many of the suboptimal behaviors that people face when making long term plans like retirement planning or financial planning, in general. We always have more pressing needs and priorities in the present, and saving tomorrow always sounds better than saving today, until it may be too late.

Most of us struggle with present bias to some extent, but if we can define the problem, maybe we can find a solution. Here are some things that may help you overcome the bias.

Educate yourself

For some people, some financial education works well. The idea is to create awareness of the connection between your actions today and your future. A review of your expenses can create awareness about your spending habits and identify potential savings. A financial projection can show the value of your savings for your future goals. The simple process of working towards financial tasks such as these can help you overcome the bias.

You may be reluctant because you do not like to work with numbers, or you may be afraid of what you find. However, you should know that getting started does not require perfection. There are many ways to get a first budget done, so do a bit of research and find what may work for you.

For your retirement, make a retirement projection so you can quantify the value of your savings, or use a savings calculator to visualize how much you can accumulate with simple savings habits. Knowing the potential of your savings is the first step towards financial independence. You don’t have to do this on your own either. Ask for help from a friend or family member or work with a financial planner.

Save More Tomorrow (but plan today)

Commitments can help solve the present day bias because they make it costly to revise your decision when you get to it. Ordering fruit today for next week may help you avoid switching to chocolate later on. Since we are prone to make better decisions for our future selves than our present selves, commitments help us capitalize on that bias. Shlomo Benartzi and Richard Thaler, professors at UCLA and the University of Chicago respectively, developed a framework to help savers overcome the present bias called Save More Tomorrow and have been successfully applying it to employer sponsored retirement plans.

The first step is to make a commitment in the present about some future time “t.” For big changes, make “t” further out. For example, you can commit today (in June) to save 80% of your year-end bonus. Another commitment could be to start saving the salary increase that you expect in the new year, and automate that level of saving. Finding a trigger, like the yearly bonus, a compensation increase, a tax refund, etc., can help you make the commitment.

The best way to keep the commitment is to make it costly to reverse it later on. Automating the extra savings can help you turn inertia and procrastination to your advantage, since you actively have to make a change to undo the plan. Talking about your commitments with a friend or significant other that can hold you accountable, at least emotionally, is another way to make the commitment stick.

Put planning on your schedule and make a plan

A good way to make financial commitments that stick is to make a plan that connects your values, goals, and actions.

Values represent the emotional payoff with a particular goal. Achieving financial independence, spending more time with the family, a successful career, giving back to your community are all examples of values.

Goals are measurable objectives that require planning to achieve. Accumulating $100,000 in 10 years to help your kids go to college, retiring at age 60, starting a business in 10 years, and so on, are all measurable goals.

Actions include things you can do, starting today, that will help you achieve your goals.

Advisors and people that go through the process of planning will tell you that it works, which is a reason why financial planning is a growing service. The approach also has academic support. Research shows that a hierarchical framework of values, goals, and actions can help develop characteristics like grit and self-control, which are found to be key determinants of long term success.

Self-control helps you avoid the present bias and establish actions that help you stay on track for your goals. Grit, on the other hand, is what makes us persevere in the pursuit of a goal despite setbacks. One reason why planning works is that it helps you create a connection with your future self, as other research has shown. A plan does not have to be complicated or by the numbers to make that connection, it is the thought process that matters. A simple, one-page plan can provide a strong foundation, so try our one-page-plan process.

Whether it is a psychological bias or just a fact of life, prioritizing our future goals over the present is a difficult task for everyone. However, we can make better decisions by creating a clearer connection between our present selves and our future selves. And getting started in that direction is not too complicated or time consuming. This week, commit to an hour of planning, once a week for the rest of the four weeks, and try out our suggestions!

About the author: Massi De Santis, Ph.D., CFP

Massi De Santis is an Austin, TX, fee-only financial planner and founder of DESMO Wealth Advisors, LLC. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow, and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.

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