Understand the Science of Saving for the Future

Saving for the future is hard, so advisors encourage long-term thinking.

A look at chronic savers who stockpile cash while forgoing everything from food to doctor visits
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Just paying bills each month can be a massive psychic drain. After covering living expenses, costs like kids' college, weddings and retirement can seem like distant planets you'll need to reach far in the future.

In fact, many of us start with the view that our financial resources will never cover our long-term needs. But that can be self-defeating, experts say. You probably have more to work with than you think, and if you are thinking of long-term goals now, you already have one of the most valuable resources in the investing ecosphere: time.

Not that it won't be challenging. Behavioral science suggests that we are not so good at those long-term decisions. In some ways, we haven't evolved much from cave dwellers whose 401(k)s consisted of four days of food.

Still, financial advisors have found it useful in helping explain how peoples' shortsighted decisions cost them dearly, and how to curb those bad decisions.

[Read: Money or Honesty: Which Do Investors Want Most From Money Managers?]

"One of the first things I do with a client is to have them imagine someone who is dependent on them and it can be a real motivation to act," says Arden Rodgers, a financial advisor who owns Arbus Capital Management. "A proud parent who pictures their child at graduation has something to save for."

Studies show that people need to visualize the future impact of their savings, like an athlete who trains hard for Olympic gold. He cites a study by New York University assistant professor Hal Hershfield that shows people make better financial decisions on surveys after being shown digitally altered pictures of themselves at an older age. It's like holding up a mirror for people, Rodgers says.

Unlike our Stone Age predecessor, we can use our math skills and longer life spans to build resources for the really long term, Rodgers says. He lays out in dollars and cents the impact of putting college money aside as soon as a child is born.

Parents who save $10,000 a year will have $309,000 for college. (That assumes only a 6 percent annual return over the 18 years through high school graduation in some kind of tax-sheltered savings plan such as creating a separate account for the student-to-be, or using a 529 plan.)

[See: 10 Target-Date Funds Producing High-Grade Nest Eggs.]

If they instead wait until the child turns eight, that $10,000 will add up to $132,000 – less than half of the 18-year plan, using the same average returns.

"People always think they can make up for a late start with better investments. They can't," Rodgers says. "It's just not possible." Do the math. To invest well enough to make $309,000 at the eight-year mark, they would need to get annual returns of 23 percent, he says. That's a figure that even the Warren Buffetts and George Soroses can't match. Still, he says, people irrationally believe they can do it.

Overestimating potential gains is a widespread problem for savers who think there are shortcuts. Finding the stocks or sectors that will be strong 20 years from now is a difficult undertaking. Look at retailing, one of the most resilient sectors of the economy year after year.

"Underestimating the ability of Americans to spend money is not a particularly profitable strategy," says Brad Sorensen, director of market and sector analysis at Schwab Center for Financial Research. But that doesn't mean it's easy to make money picking stock winners in the highly competitive retail market. Shares of Wal-Mart trade just $5 above their level in 1999. "You really have to stay diversified or you could end up on a real roller coaster," he says.

[Read: How Markets Misunderstand the Fed's 'Taper' Economy.]

"How many investors have you met that are truly effective long-term investors?" asks Robert Weller, co-head of behavioral finance equity at Sterling Capital Management, which has started using behavioral research to guide some of its equity funds. "The underlying data shows investors never fully participate in the markets' gains. They sell at the wrong time and buy at the wrong time."