Have you thought about retirement? What images come to mind?
I recently wrote about the top ten words people use to describe retirement, and the most popular words paint a positive experience such as relax, fun, and happy. Why is it then, that there are a large number of retirees who are not as happy in retirement as they predicted? We can only blame ourselves. Most traditional retirement planning focuses on the financial aspects of retirement – topics including asset allocation, safe withdrawal amounts, and Social Security. However, there are many non-financial factors that contribute to retirement success that play a significant role. I discuss several of these in my retirement satisfaction webinar.
According to a research report by Melissa Knoll, a research analyst with the Office of Retirement Policy at the Social Security Administration, there are many reasons why we misjudge retirement. The research finds several culprits including affective forecasting.
What is “affective forecasting”? Think of weather forecasting. You are trying to predict the future based on the limited information you have today. However, instead of predicting tomorrow’s temperature, affective forecasting is about predicting your future emotions and happiness. Similar to weather forecasting, though, we’re just as bad at seeing into the future as your local weather person.
According to Knoll, “Affective forecasting is a crucial aspect of decision making because it allows individuals to anticipate how they would feel if they engage in one course of action or another.” We constantly make decisions today based on how we think we might feel in the future. Affective forecasting is the process we use to make many of these decisions – some are trivial, but others, like when to retire, have lasting and significant consequences. If we are bad at predicting what’s going to make us happy, we are bound to make a lot of less than ideal decisions.
For example, if you are considering retirement, you are likely to think about how your life and your happiness might be impacted if you continue to work or if you retire. If you inaccurately predict that working another three years will make you miserable and that retirement will be carefree and joyous, this can create both financial and non-financial problems.
The goal is to be able to accurately predict what will make you happy in the future, and researchers have found that humans have the unique ability to “pre-experience” future events. Based on these mental simulations we make predictions about how we will feel. Knoll writes, “The particularly troubling aspect of affective forecasting is that individuals’ prospections are often inaccurate, but they drive behavior nonetheless.”
Research on affective forecasting tells us that we tend to over or under estimate how an event will affect our future happiness – that is, we imagine the event to be much better or worse than it actually turns out to be. If you’ve worked thirty years and have had a bad day at the office, you will probably overestimate how wonderful your life in retirement might be. This mental “pre-experience” you envision may entice you to think about retiring early – even if you may not be financially or emotionally ready.
Here is why we are poor predictors of what will make us happy:
Our mental simulations are unrepresentative. Behavioral economists have found not all experiences carry the same weight. We typically remember only the best or the worst events and forget everything in between. Even worse, we have a negativity bias, which is our predilection to remember negative events more than positive events. These are the ingredients for potential failure. If you are thinking about retirement, you may look back on the year and only remember the handful of bad days and disappointments but forget about the decent or good days.
We often make the mistake of focusing more on the main features of the event and discounting the minor (but still important) details. When thinking about retirement, we may think in terms of traveling more and having free time, but fail to consider all of the days we are not travelling and what we will do with all of the free time.
In our retirement daydream, we tend to focus on only the earliest aspects of retirement such as not having to wake up early the day after retiring, enjoying the holidays without the stress of work, and playing golf in the middle of the day. These are all valid reasons to feel good about retiring, but they do not represent the full picture in retirement. The author suggests that the delayed effects of retirement are most likely underrepresented in the mental simulations of retirement, even though they are experienced in actual retirement.
This is a fancy word that simply means the factors in your life when you think about the future may be different or not present at the time the event actually occurs. This can affect your retirement decision in two ways. First, when you are still working you may have very little leisure time, and any leisure time you have you can easily fill with projects or hobbies. Thus, you may look forward to a retirement with more leisure time but fail to realize that you enjoy your leisure time now because you have so little of it and it is easy to fill. It’s hard to imagine a future where you have considerably more free time than you have today. Second, when you decide to retire you are enjoying the benefit of an income. Again, since this is your current reality, it’s hard to imagine a future scenario where you can truly understand what it will feel like without an income.
5. Impact bias
Affective forecasting and the four issues described above focus on how we will feel in the future, but impact bias focuses on how long we will feel this way. Those who study impact bias find that we overestimate the intensity and the duration of the emotions about a predicted future event. In other words, we think this imagined event will be amazing and that it will last forever, but in reality it doesn’t make us as happy or for as long as we think. It’s not hard to imagine how impact bias can influence the timing of our decision to retire.
These are the factors that can lead us to make less than optimal decisions about retirement. What’s the solution? Awareness shouldn’t be underestimated. Just knowing we are all prone to take these mental shortcuts will help us make better decisions. Also, to give weight to the positive and the negative, consider completing a pre and post retirement matrix where you think deeply about the good and the bad when it comes to continuing to work and the good and the bad of retirement. Give the good and the bad equal thought and time and focus on the specifics. Retirement is one of the financial transitions that will change your life forever. Take your time, and if you want to learn more about how to create a better retirement experience, sign-up for the free retirement satisfaction webinar.
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