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:
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.
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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.
What other advice do you have for retirement savers?
Automation is key. If I ask you how much you earned last or this year, my bet is that you'd immediately think of a gross number—$50,000, $100,00, whatever, but it's not true. After taxes, it's dramatically less. People don't think of that. The beauty of automatic withholding is that you can make saving and investing more painless.
People need to educate themselves on the classic errors and think about future dollars. If you're 50 today, think about how every dollar you spend is $7 or $8 that you won't have in your retirement account because of the time-value of money and inflation, if you invest it instead of spending it.
A car purchase is a common example. A young couple is thinking about spending $25,000 on a new car versus a very nice, preowned car that will last every bit as long for $12,000. They don't think about that as a retirement decision. They think about it as a transportation decision. Should you spend it or put it in an account? The only question they think about in whether they should spend $12,000 or $25,000 is 'Do we have $25,000?'
What can people nearing or of traditional retirement age—who have seen their savings crushed or haven't' saved enough—do?
Because of their behavior and age, they are basically at the mercy of the prevailing social welfare systems ... Unfortunately, some 40 percent of Americans have essentially saved nothing for retirement. My intent with the book is to help investors understand some of these past mistakes, and start thinking about what they can do to take personal responsibility for their retirement preparedness moving forward.
Where do you stand on target-date funds?
They got rocked pretty bad during the meltdown. What was perhaps most disheartening is that some of the funds with the earliest horizon dates got hammered, which caused great deal of distress. A lot of research shows that they're very misused. The whole concept of a target-date fund is that it holds your entire retirement portfolio, but perhaps the lesson here is that diversification—and building a plan that is customized to your unique objectives—is important when planning for retirement.
People are looking again at annuities, which have historically not always been treated well in the mainstream media. They're looking a lot better these days ... Historically, advisers might have said to investors: 'Give me all your money and I'll design a portfolio that gives you a 90 percent chance of having money for the rest of your life.' Given the events of the last couple years, you don't want a pretty good chance, you want a guarantee.
What's the biggest mistake people make when it comes to their retirement finances?
It would be difficult to pick one, but thinking that retirement is an event—that's probably the most damaging. Seeing it as being out there at some future point and thinking you don't have to worry about it until you reach the zone.
There is a lot of marketing that promotes this concept that there's a zone, that the five years prior to retirement are somehow hypercritical. But if you understand compounding of interest, you start to see that perhaps the saving and investing decisions made at ages 20 to 24 are just as—if not more—important than the decisions made at ages 55 to 59.
This zone approach leads to one of the classic errors, which is thinking about retirement as a thing that's separate from your other finances. Retirement preparedness is impacted by all of your financial decisions. Spending, saving, investing, retirement planning—all of these issues and financial decisions are inextricably bound.