Psychology of Money for the Retiree

Psychology of Money for the Retiree – Welcome to the Webinar (0:00)

Alex Call: Hello, everybody. Welcome to the webinar today. It looks like a few people are still taking some time to join, so we’ll give it another minute or so to let everyone trickle in.

I’m looking forward to discussing the psychology of money for retirees today. While people are joining, I’ll go ahead and introduce myself. My name is Alex Call, and I’m a Certified Financial Planner™ at Peterson Wealth Advisors.

Before we dive in, a couple of quick housekeeping items: If you have any questions during the webinar, please feel free to use the Q&A feature located at the bottom of Zoom. Zach, another financial advisor here at Peterson Wealth, will be answering your questions as they come in. If we have any questions left at the end, I’ll set aside some time for a Q&A session.

Additionally, you’re always welcome to send us an email if you have more individualized questions or need a more personal response. We’re happy to help.

Finally, at the end of the webinar, there will be a survey sent out. Please provide feedback and suggestions for future topics. Your input is invaluable in helping us improve and better serve your needs. With that, let’s jump right into it.

As with all our webinars, just a quick disclaimer: The information provided in this presentation is not intended to constitute legal, investment, or tax advice. It is provided for general informational purposes only.

Understanding the Psychology of Money for Retirees

Now, let’s dive into the psychology of money for retirees. The purpose of this presentation is to highlight that managing money relies much more on your temperament and behavior than on any intelligence or intellect you may have. Don’t just take my word for it; Warren Buffet said, “The most important quality for an investor is temperament, not intellect.” Napoleon expressed a similar idea, saying, “Genius is the man who can do the average thing when everyone else around him is losing his mind.”

Why is that? Because money is tied to emotions, and the better you can manage your emotions, the better you can handle your finances. Understanding how you think about money can significantly improve your financial decisions throughout retirement.

We make hundreds of decisions every day. Sometimes, we can think about them carefully, but other times, we make them on the fly using very little information. This is where heuristics, or mental shortcuts, come into play. These mental shortcuts are tools that help us make quick decisions or judgments. We use them not because we’re lazy or our mental resources are limited, but because there’s an overwhelming amount of information in the world. Life would be exhausting if we had to deliberate on every choice we make, so instead, we use these shortcuts to navigate the world around us.

For example, when you go out to eat at a place like Cheesecake Factory, where the menu is 10 to 15 pages long, instead of going through every possible option, you might order something you’ve enjoyed in the past or something a friend or server recommended. These shortcuts aren’t about making perfect decisions; they’re about making decisions quickly and efficiently.

However, sometimes these mental shortcuts can get us into trouble when they’re left unchecked. When this happens, they can turn into cognitive biases—errors that arise from our mental shortcuts and often go against logic or probability. Although we like to think of ourselves as rational beings who process all the information before making a decision, this is often not the case. Everyone is prone to cognitive biases to some degree.

For example, you rarely hear about shark attacks, so you assume swimming in the ocean is safe. But then, one day, you click on a shark attack video on Instagram, and suddenly the algorithm is sending you more and more shark attack videos. Now, you believe that shark attacks are much more common, and you may develop a fear of going into the ocean, even though millions of people swim in the ocean every year and there were only 69 attacks worldwide in 2023.

This illustrates how, if our mental shortcuts are left unchecked, they can lead us to perceive the world in ways that don’t reflect reality. These biases are largely based on our experiences. Everyone has their own unique experiences that shape how they view the world, and what you experience firsthand is always more compelling than what you learn secondhand. As a result, we all go through life anchored to a set of views about how money works that can vary significantly from person to person. What seems crazy to you might make perfect sense to me.

The person who grew up in poverty thinks about risk and reward in ways that the child of a wealthy banker never could.

As Charles Dickens said, “It was the best of times, it was the worst of times.”

John F. Kennedy was once asked about his memories of the Great Depression while he was running for president. His response was, “I have no firsthand knowledge of the Depression. My family had one of the great fortunes of the world, and it was worth more than ever. I really did not learn about the Depression until I read about it at Harvard.”

Clearly, his experience of the Great Depression was vastly different from the millions of Americans who struggled to provide for their families during that time. Because of this, their views and biases about money are also very different.

Common Financial Biases Retirees Face

These biases, developed over time, will follow you into retirement. So, we’re going to examine them from a retiree’s perspective, focusing on the most common biases I have encountered while working with retirees.

The first are loss aversion and negativity bias. Next, we’ll discuss optimism bias and recency bias.

As we go through these, you might notice these biases more in others than in yourself. That’s normal because it’s often harder to recognize these biases in ourselves.

While we can’t cover all the biases out there—there are hundreds of them—we will explore strategies for mitigating their impact on money management, both before and during retirement, by developing a framework for how to think through these biases.

Loss Aversion and Negativity Bias (9:03)

Let’s start with loss aversion and negativity bias. I group these together because they are closely related.

First, loss aversion.

Loss Aversion

Loss aversion is the tendency to prefer avoiding losses rather than acquiring equivalent gains. In other words, losing feels worse than winning feels good. As Larry Bird once said, “I hate to lose more than I like to win.”

Let’s try a thought experiment. Imagine I come up to you and say, “I’m going to toss this coin once. If it lands on heads, you get $1,000. If it lands on tails, you have to give me $1,000.” Would you take that bet? Or, how much would I have to offer you to make it worth the risk of losing $1,000?

Studies have shown that, on average, people would need to win twice as much to take the risk of losing. In other words, I would have to offer you $2,000 to get you to take the risk of losing $1,000. This suggests that people are willing to leave a lot of money on the table to avoid the possibility of losing because losses can hurt twice as much as wins feel good.

It’s the same thing with investing. It hurts more when the market goes down than it feels good when the market goes up. This is called loss aversion. Understanding loss aversion can help us see how the fear of losing money can strongly influence our decisions, often more than the chance of gaining money.

Negativity Bias

Now, onto loss aversion’s cousin, negativity bias.

Negativity bias means we give more weight to negative experiences or information than to positive ones, leading to an overemphasis on negative events.

Imagine you’re at dinner with your significant other, like I will be tonight, celebrating my 10th anniversary with my wife. Picture this: as we’re sitting there, I start complimenting her, saying, “Kim, you have the prettiest eyes. I love your outfit. Your nose is a little crooked, but you have a smile that lights up the room.”

What do you think she’s going to focus on? Probably the crooked nose. How many compliments will it take to get me out of the doghouse—five, ten? There’s probably not enough. And that’s normal because we tend to focus more on the negative things people say to us than on the positive things.

The Impact of Loss Aversion and Negativity Bias on Investing

This isn’t any different in investments. Retirees and investors tend to focus on negative market outcomes more than positive ones. When you combine loss aversion and negativity bias, it gets even worse. Not only are you more likely to focus on the losses in the market, but those losses feel much worse than the gains do, leading to an even stronger bias towards avoiding loss.

There’s one more reason why it’s so easy to focus on negativity instead of the positive: progress is slow, while destruction is fast. Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds. It takes years to build a reputation and seconds to destroy it.

Consider the progress of medicine. Looking at the last year won’t show much, and even a single decade might not reveal much more. But if you look at the last 50 years, you’ll see something extraordinary. For example, the age-adjusted death rate per capita from heart disease has declined by more than 70% since 1965. That’s enough to save roughly half a million American lives every year—the equivalent of the population of Atlanta being saved every single year.

But because that progress happens so slowly, it captures less attention than quick, sudden losses like terrorism, plane crashes, or natural disasters. This same mentality applies to investing, where we tend to focus more on the negative things happening around us.

So, let’s look at some of the negative events and turmoil that have occurred in the past hundred years in the U.S.

If we look back, we had World War I, then the Spanish flu, the Great Depression, World War II, the Cold War, the Korean War, the Vietnam War, the Cuban Missile Crisis, the assassination of John F. Kennedy, followed by the assassination of Martin Luther King, double-digit inflation in the late seventies, the dot-com bubble, 9/11, the Great Recession, and COVID-19—those are just the first 15 events that came to mind. There are many more that aren’t listed here.

Market Declines and Recovery Patterns Over Time

During this time, the stock market also experienced significant volatility. There have been over 40 declines of 15% in the market, which averages out to about once every three years. Declines of 25% have occurred over 20 times, or about once every five years. And 40% declines have happened eight times, approximately once every 15 years.

If this pattern continues over a 30-year retirement, you might experience 10 declines of 15%, six declines of 20%, and two declines of 40% or more while retired.

Listening to your negativity bias might lead you to avoid stocks, opting for safer investments like cash or bonds instead. But let’s see what would have happened if you had invested in cash or bonds instead of stocks over the last 100 years.

Since 1926, if you had invested $1 in cash or Treasury bills, that dollar would have grown to $23. If you had invested that $1 in bonds, it would have grown to $133. Now, let’s see what that $1 would have grown to if you had invested in stocks, despite all the turmoil and volatility that occurred.

That $1 would have grown to $14,568.

If you had let your biases drive you to invest conservatively due to fear and negativity, you would have ended up investing in cash or bonds, missing out on the high returns of the stock market.

Now, to clarify, I’m not suggesting that you invest all your money in stocks during retirement, but I do recommend having a significant portion in stocks. The reason is that listening to your negativity bias and avoiding stocks during retirement is going to negatively impact your life.

Impacts of Avoiding Stocks

How will it negatively impact your life? First, it will result in a lower standard of living. You’ll be limiting yourself to this lower standard if you keep your money in cash and bonds, missing out on the higher returns of stocks.

Second, you won’t be able to beat inflation. Investing in stocks is the best way to keep pace with inflation over the long term.

Finally, it will cause undue stress and anxiety by always focusing on potential negative outcomes instead of allowing you to live in the moment and enjoy retirement.

Now that you know some of the consequences of listening to negativity bias, how do you go about mitigating these biases?

First, know when you should be invested in stocks versus bonds. This depends on when you need the money. It’s about matching your investments with your income needs.

Here’s a cheat sheet or a mental shortcut to know how money should be invested in stocks or bonds. Money that you need in the next, say, zero to five years should be invested in fixed income. With interest rates being so high, this would include bonds, CDs, or high-yield savings accounts. The reason is that average market downturns last about 12 months, and you don’t want to stress about the money you need in the next 12 months being invested in stocks and their associated volatility.

Next, money you don’t need for the next six to ten years should be invested in a mix of stocks and fixed income. And money you don’t need for 10-plus years should be invested primarily in stocks. This is because downturns only last, on average, 12 months, so you can benefit from the upside of those higher returns.

Like I said, this is a good rule of thumb or mental shortcut. Your specific situation may warrant something different. For those of you just a couple of years from retirement, it may seem like you need to put everything in your 401(k) into fixed income, but that’s not quite the case. You’re not going to spend all of your 401(k) the day you retire. When you retire, you might live another 30 years, which means you’ll only be spending a small portion of your portfolio each year.

In addition to matching your investments with your income needs, here are two other things you can do to mitigate negativity bias:

First, schedule regular reviews. I don’t recommend checking the market every day or every minute to see what’s happening, but I do recommend scheduling regular reviews, whether it’s quarterly, biannually, or annually, to see how you’re progressing.

Second, practice gratitude. Focus on what you have achieved instead of the potential losses that may occur.

Now, a quick caution: I’ve met many people who blame their negativity bias or fear of investing in stocks on their religious beliefs, assuming the world is coming to an end tomorrow. I have listened closely to every session of General Conference for years, and all I have heard is optimism for the future. Temples must be built, missionaries need to be sent out, and technology needs to be enhanced for prophecies to be fulfilled. There may be a time immediately before the Savior’s Second Coming when the world is in chaos, but there’s no way to plan for chaos or know when it will happen.

So, let’s not dwell there. I really think President Hinckley expressed it best when it comes to how we should think about negativity. He said, “We have every reason to be optimistic in this world. Tragedy is around—yes. Problems are everywhere—yes. But you don’t build out of pessimism or cynicism. You look with optimism, work with faith, and things happen.”

Being optimistic in the markets means believing that we will continue to build and progress. I also love how President Hinckley did not say that things would go exactly according to plan, that there would be no problems, and that everything would be all sunshine, rainbows, and roses. That’s not the case. But when we assume that it will be, we can fall into the trap of optimism bias.

Optimism Bias (22:38)

Optimism bias is the tendency to overestimate the likelihood of positive outcomes and underestimate the likelihood of negative ones. This bias leads individuals to believe they are less likely to experience adverse events compared to others. While it can encourage a positive outlook, it may also result in underestimating risks and not preparing adequately for potential challenges.

I’m sure many of you have probably had some home renovation project or built a home or something similar. Think back to when you had that project. I’m guessing it was probably less expensive than you thought it would be, and it didn’t take as long as you expected, right?

No, of course not. These things almost always take longer and cost more than we initially think they will. That’s because we allow ourselves to be influenced by optimism bias.

Now, I want to share an example of this with a client I had, whom we’ll call Mr. and Mrs. Optimistic. These were hardworking, blue-collar people—one was a miner, the other a nurse. They saved their whole lives and were ready to enjoy retirement with a nest egg of over a million dollars—more money than they ever thought they would have. However, Mr. and Mrs. Optimistic are currently exhibiting optimism bias, which is influencing their financial decisions in a potentially harmful way.

They expect that between the investment returns on their million dollars and the potential inheritance coming their way, they can spend whatever they want, whenever they want. Because of this optimism bias, they are spending their retirement savings at an unsustainable pace, enjoying frequent vacations, luxury purchases, and an overall lavish lifestyle. They dismiss any concerns about their spending, relying on their optimistic beliefs that market returns and the expected inheritance will justify their actions.

But then reality hits. Market returns are not keeping pace with their spending, and the inheritance they expected turns out to be much smaller than they thought, leaving them without the financial cushion they believed they had.

As their savings dwindle faster than anticipated, they are left with one of three options:

  1. Risk running out of money during their retirement.
  2. Make a challenging transition to a more modest lifestyle.
  3. If they can, they may have to go back to work.

Ultimately, when it comes to the consequences of optimism bias, it’s clear that whenever reality does not match expectations, it causes significant stress.

So, how do we combat optimism bias? I’ve found that the best way is to have conservative yet realistic assumptions when creating your income plan. This includes using conservative assumptions for returns. For a diversified portfolio of 60% stocks and 40% bonds, the average return has been about 7%. What does that mean? It means that a conservative approach would not assume a higher return than that—perhaps even a bit lower than that 7%.

Next, consider inflation. Inflation is real. You’re going to spend more dollars 10 years from now than you do today because things will cost more at that point. Make sure to include inflation in your plan.

When it comes to inheritance, remember that nothing is official until the money is in your bank account. Unless you’ve discussed the amounts with your parents and have seen exactly how it will be distributed, don’t rely on an inheritance to save you. Even then, I would be conservative in how much you expect to receive.

Another factor is life expectancy. People are living longer these days. If you and your spouse are both 60 years old, the chances that one of you will live to be over 90 are more than 50%, and healthcare is only getting better.

Next, consider your budget. People often think they can stick to their budget better than they actually can. I recommend creating a budget, listing everything down, and then adding a 10% buffer to it. This will give you a more realistic picture of what you’ll actually be spending your money on.

Lastly, remember that you’re going into a time when you might have more money than you’ve ever had. It might be hundreds of thousands of dollars, perhaps over a million or even millions. That’s a lot of money, but providing income for decades in retirement takes a lot of money too.

By using these conservative assumptions in your planning, you’ll be able to curb any optimism bias you might have.

Recency Bias (28:42)

Now, the next cognitive bias we’ll focus on is recency bias.

Now, let’s talk about recency bias. This bias is all about the attitude of “what have you done for me lately?” It favors recent events over historical ones. Recency bias causes people to give extra weight to recent experiences when making decisions, often at the expense of a more balanced view of the overall context.

A classic example of this is performance reviews at work. If you have an annual review, chances are your recent performance, especially in the last month, will be weighed more heavily than what you did at the beginning of the year.

For example, if we look back at the last five NBA champions (not including this year), three of those five head coaches were fired shortly after reaching the pinnacle of success. This demonstrates how recency bias can influence decisions, even in high-stakes environments.

So, what does this mean for you and your money?

Recency bias is like adding fuel to the fire. It can intensify our negative bias during market downturns, making us more negative than warranted. Conversely, during market upswings, it can boost our optimism bias, leading us to become overly confident.

When it comes to money, recency bias can be broken down into two categories. The first is reacting to what the market has done recently, and the second is reacting to current or recent events.

Let’s look at a chart that illustrates what happens when we react to what the market has done recently.

In this chart, you’ll see a green line representing a $10,000 investment made in 1992. The green line shows how that investment would have grown over time. The orange line shows what would happen if you sold your stocks and moved to cash at various points.

As you watch this, see if you notice any trends.

This video ends in October 2022. I’ll give you one guess as to what happened since then. The market shot back up, and as of the end of July, that $10,000 would now be worth $246,000.

This type of recency bias is when we become fearful and sell when the markets are down, or on the flip side, buy when the market is high, instead of staying the course. The lesson here is to think long-term and not be swayed by the ups and downs of the market. Remember, retirement is measured in decades, not years.

Now, let’s discuss a different kind of recency bias—allowing current events to dictate how you invest. A classic example of this is letting politics influence your investment decisions.

Let’s consider three different investors. The first is a Republican who only invests when a Republican is president. The second is a Democrat who only invests when a Democrat is in office. The third investor doesn’t mix politics with investing and stays the course no matter who’s in office.

Now, let’s see how their investments would have performed if we look at the track record going back to just after World War II.

This chart shows the growth of $10,000 invested in U.S. stocks since 1949. The red line represents the Republican. If you only invested when a Republican was in office, your $10,000 would have grown to $80,000. If you only invested when a Democrat was in office, that $10,000 would have grown to just over $400,000. And if you stayed the course and didn’t mix politics with investing, that $10,000 would have grown to just under three and a half million dollars.

The two lessons here are: first, never let your politics get in the way of your investing. Second, don’t let recent events impact your investment strategy.

If we let recency bias get the best of us, two primary things can happen:

  1. You’ll let returns determine your mood. Your happiness will depend on whether the market went up or down that day.
  2. You’ll constantly jump in and out of the market over time, likely losing money and not being able to enjoy retirement.

So not only will recency bias affect your money, but it will also affect your mood, preventing you from being present and in the moment. This is why it’s crucial to ensure that these biases don’t go unchecked.

So, how do we mitigate recency bias?

The first step is maintaining a historical perspective. This involves looking at long-term market trends and historical data, as we just did, rather than focusing on recent performance.

The second step is adopting a long-term time horizon. This means planning investments over a longer period, such as decades, rather than reacting to short-term market movements.

When we look at overcoming loss aversion, negativity, optimism, and recency biases, it’s about not being too optimistic or too pessimistic. It’s about controlling our temperament. Like Goldilocks, it’s about finding what’s just right.

Mitigating Other Biases (36:27)

Now, I want to discuss developing a framework for mitigating other biases.

The pioneering behavioral economist Daniel Kahneman said, “Maintaining one’s vigilance against biases is a chore, but the chance to avoid a costly mistake is sometimes worth the effort.”

Because there are so many different biases out there that we can’t cover today, let’s talk about a framework that will help you make decisions and protect you from any biases you might have.

I like to use the acronym ASK because you’ll need to ask yourself and others questions to mitigate your biases.

The A stands for Awareness, the S stands for Seek advice, and the K stands for Know your goals.

So, the first step to awareness is acknowledging that you are not immune to cognitive biases. Like everyone else, you have mental shortcuts that can lead to biases affecting your decision-making process.

Next, be aware by educating yourself—like you did today—about the biases that exist. Then, look for them when making decisions. Also, question why you think a certain way. Is it based on facts and historical data, or is it driven by emotion? Asking yourself why you believe something helps you become more aware of the biases you may have.

Finally, slow down. If you have a big decision to make, take the time to process the necessary information and don’t feel rushed. Don’t feel pressured to sell your investments or to buy a product from someone trying to sell you something.

The next step is seeking advice. Whether you seek professional advice or advice from a trusted contact, there are many benefits.

The first benefit is having an objective perspective. This allows you to take the emotion out of the situation and get an unbiased view of your financial situation and decisions.

Next is expertise. Financial advisors have specialized knowledge in areas like retirement planning, tax strategies, and investment management, and they’ve seen many people go through retirement.

Lastly, there’s accountability. Regular meetings with an advisor or a trusted contact can help keep you on track with your goals and prevent emotionally driven decisions.

But before you start seeking advice, you first need to know where you’re going. As the Cheshire Cat says, “If you don’t know where you want to go, then it doesn’t matter which path you take.”

This is why you need to know your goals. Having clearly defined goals for what you want in retirement will impact the type of advice you receive. If you don’t know what you want, even the best, most qualified advisor in the world can’t help you achieve your goals.

First, define your goals, and then prioritize them. Do you want to maximize your income in retirement? Is leaving a legacy to your kids more important? Do you want to retire now with slightly less income or retire later with a bit more income?

Remember, your goals are your goals, not anyone else’s. One of the most common questions I get when meeting someone for the first time is, “Do I have enough money?” I always tell them, “It depends on how much money you want to spend in retirement.” Some people get by on $3,000 a month and are super content and happy. Others struggle to get by with $25,000 a month.

So, the question of “Do you have enough?” depends on what you want.

I feel Elder Perry sums it up nicely: “You are not competing with anyone else. You are only competing with yourself to do the best with whatever you have received.”

Your goals will be dictated by how much money you currently have and when you plan to retire. You need to find out what works best for you as you determine what your goals are.

It’s important to note that this is a great opportunity. Retirement has only been around for a few generations. People in the past did not have the luxury or opportunity to retire; they worked until they died. We are now seeing people enjoy retirement for 20, 30-plus years—almost a third of their lives. This opportunity means that your generation has a chance to do something few others ever had: the opportunity to help others.

I like how President Benson puts it: “Our desires are that your golden years will be wonderful and rewarding. We hope your days are filled with things to do and ways in which you can render service to others who are not as fortunate as you.”

Retirement is an opportunity to render service to others who are not as fortunate as you. I hope that you’re able to enjoy your retirement.

So, in summary, we talked about the four primary biases that I see retirees struggle with: loss aversion, negativity bias, optimism bias, and recency bias. Then, we looked at a framework to mitigate other biases, using the acronym ASK: Acknowledge, Seek advice, and Know your goals. Finally, remember that retirement is an opportunity to serve. I hope you’re able to enjoy that opportunity as you prepare for retirement.

Thank you very much for attending.

Question & Answer (43:24)

Zach, were there any questions that came through?

Zach Swenson: Nothing came through, Alex. But we’ll give it a second to see if anything does.

Alex Call: Okay. If not, please feel free to reach out with any questions. Also, one thing I wanted to point out is that we’ve had a lot of people ask for a copy of the “Plan on Living” book that Scott Peterson wrote. Many of you have probably received a copy, and some of you have asked for another to give to a friend or colleague. If that’s the case, we’d be more than happy to either send them a book or send you an extra copy to give to them. Please just let us know, and you can respond via email, and we’d be happy to do that for you.

So, it looks like there are no questions coming in. Is that right, Zach?

Zach Swenson: Yep, that’s correct.

Alex Call: Okay, perfect. If you could, I would love it if you could take the time to fill out the survey. I always appreciate feedback to know how I can do better and also to learn what topics you’re interested in, so we can cover those in the future.

Thanks, and have a great day.

About the Author

Alex Call is a Certified Financial Planner™ at Peterson Wealth Advisors. He graduated from Utah Valley University where he majored in Personal Financial Planning and minored in Finance.

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