Understanding the Psychology of Retirement Planning

How a lifetime of financial behavior—earning, saving, investing—ultimately affects your retirement

August 2, 2010 RSS Feed Print

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Perhaps one of the greatest financial missteps people make is believing that retirement is an event or a "zone" one enters later in life. So says Gregory Salsbury, author of Retirementology: Rethinking the American Dream in a New Economy. Salsbury sees it more as a process: "All of your financial behavior—earning, saving, borrowing, investing—impacts your retirement. It begins as soon as you're able to put money away, not sometime in the future," he says. "People often think they don't have to worry about retirement because they're not yet in the zone—they still have 20, 30, 40 years to worry about it."

In his book, Salsbury examines how psychology plays into financial choices that can have dire consequences down the road. U.S. News recently spoke with Salsbury about the psychology behind retirement planning, including mistakes people make early on that can affect retirement. Excerpts:

[See U.S. News's list of The 100 Best Mutual Funds for the Long Term, and use our Mutual Fund Score to find the best investments for you.]

What's behind Retirementology ?

Retirementology is about blending behavioral finance with retirement planning in the aftermath of the financial crisis. When it comes to money, people don't always make decisions rationally. They'll drive 30 minutes to use a $2 coupon. They will hold onto a stock for longer than they should because they inherited it from their grandmother ... When it comes to money, it's not supposed to be black and white. These same mindsets can also be applied to retirement planning ... The financial meltdown has been a perfect theater for all the bad behavior to display itself so clearly ... what people have done over the past 10 years has ultimately been detrimental to their retirement preparedness.

The impact was partially brought on by the bad behavior—people viewed their homes as ATM machines, thinking they'd do nothing but appreciate, and people became emboldened. 'By the way, I don't have to worry about retirement because this house will be my retirement.' Forty percent of mortgages, for example, in 2005 were for non-owner occupied homes. So people are now having to revisit their expectations for retirement—when they retire, what kind lifestyle will they have, and how much family support will they have for their aging parents. If had to wrap it up with a ribbon, one of the major themes in the book is trying to get people to stop looking at retirement as a zone and see it as a more holistic process.

In the book, I offer a new vocabulary to try to get them to grasp these sometimes very complicated concepts. Equimortis: The dangerous condition of relying on the equity of one's home to fund retirement. Bingefy: The tendency to splurge after being frugal. You give up your daily Starbucks coffee and then feel justified to bingefy on a trip to Hawaii.

[U.S. News's highlights The Best—And Worst—Places to Build a Nest Egg.]

What is your solution to help people curb this bad financial behavior?

Seek a financial adviser sooner rather than later. Too many people try to do this on their own. It's far more complicated than they think. The wisest advisers in the industry know that the biggest challenge is not investment management—it's investor management. The difference between a given product, or choosing an investment, is not nearly as impactful as the errors of investing—bailing out of an investment at exactly the wrong time, waiting too long to reinvest, trading portfolio positions too often trying to pick winners, not saving consistently.

When should you get an adviser?

As soon as you can start saving. Working with an advisor should begin as early in your retirement planning process as possible.

But young people often don't have a lot of money to spend.

It costs money, but so do brain surgeons. Would you entrust someone who is not a surgeon to conduct your operation? You need to choose your adviser wisely, of course, but I try to stress that retirement planning is a complicated endeavor that should be undertaken with professional assistance.

Tags:: stocks,; stock market,; retirement

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Start by listing all your liquid assets, cash or investments that can be easily converted to cash like stocks, bonds, etc. Categorize them by time until needed to buy something - up to 18 months (cash, Money Market), 18 to 36 months (bonds/bond mutual funds - Gov't, High Yield, International), 3 to 5 years (blended stock and bond mutual funds - Growth & Income, Equity Income, Total Return, Blend), 5 to 8 years (large company stocks, global stocks, and stock mutual funds - Growth & Global), over 8 years (small cap, mid cap, and international stocks - Aggressive Growth, International, and Emerging Market). Note: Global and International mutual funds are different. Global invest in both domestic and overseas companies. International must invest in only overseas companies. The first priority - control your cash flow. Adjust your W-4 filing to closely match your withholding to your tax bill -breakeven plus/minus $300. File W-5 for Advance EIC. Do not purchase unnecessary benefit packages, specific illness, extra life insurance, etc, Do buy short and long term disability. Don't shop at high cost sites like gas stations. Buy only term life insurance as a private policy Vs through your employer. Insurance purchsed through your company will be lost if you leave the company or the company leaves you or you will have to convert it to a high cost product with a savings component at a poor rate of return. Establish an emergency fund of at least $1500 or your take home pay (THP)(gross - taxes only). Make automatic payments to build it toward three months THP. When reached, cut those payments in half and continue to build toward six months THP. Do this step even if you have significant debt. I have never seen anyone get out of debt unless they also saved for an emergency fund. Establish a debt elimination program. Rank debt by size and interest rate. Under $500 to $1000, ignore the rate and pay off by size, smallest first. The rest rank by rate and pay highest rate first. Don't buy cars you cannot pay off within 36 months. If you have a current car loan significantly over that, sell it and purchase something you can afford. Retirement, take the free money, i.e. matched retirement plan up to the maximum match. Then fund your Roth IRA up to the maximum. If you have more resources to fund retirement, put additional into the company plan. Do not do college savings until your retirement program is on track to replace at least your current income at a 5% withdrawal rate. When you save for your childern's benefit remember there are three main ways. Coverdell Ed Savings Acct. can be used for kindergarden through college. Consider your state's 529 plan next. Finally, with kids you will need to provide for cars and weddings at some point. Use the UGMA/UTMA for your non-college savings needs. When kids have earnings, help them start emergency funds and Roth IRAs. When you have $100000 in wealth, look at funding a Long Term Care policy.

Larry Hillman of OK 5:19PM November 11, 2010

There are some good points this article brings up. But there are some basic things all people should know that rarely gets taught.
I'm going to pass on some basic stuff here. You start with a foundation, loss protection(worst case),debt mgmt(intrest works 24/7 for you or against you),short term savings(dont tap into your long term savings),& long term savings. Doing all these at the same time!
3 THINGS YOU HAVE TO KNOW!!!
TIME STOP WASTING IT. He mentioned compounding intrest you see the results at the end.
RISK VS. RATE OF RETURN. Get a decent r.o.r. with back end safety
3 WAYS TO ACUMULATE. Taxed, Taxed Deferred, Tax Exempt. Use them all.
Theres no right way for every person. So just saving isn't going to do it.
There are people out there who can help you the most expensive thing you own is a closed mind.

Chad of CA 1:05AM September 13, 2010

I have some money that I have earned in a Liquid Asset, meaning, it's just sitting there not earning any interest, but it is also not losing any of it's value.
I have been told to invest in an IRA, but I don't know how to pick out an IRA & I don't want to lose any more money in the stock market as I am approaching retirement age. Any advice?

Leah of CA 1:28PM August 14, 2010