What is the Secret Ingredient for any Retirement Planning Tool?
Search the internet for a retirement planning tool and you’ll be overwhelmed with how many sites have one. Many look really professional, precise and objective. Fill in some variables and out comes your retirement plan. Or does it?
The missing ingredient is. some unbiased brain power.
Most retirement planning is not a precise mathematical exercise but a mix of a simple financial model, skewed by biased input and wrapped up in a neat looking summary.
Why do I say this?
The reason is clear if we look at the process. As we step through the model we are asked to make a number of assumptions about issues like investment returns, inflation, how long we expect to live – but who knows about next year let alone 20 or 30 years from now?
To give us confidence in their advice financial planning specialists offer us a retirement planning tool to plan our retirement. But do they know the answers to these forecast questions any better than we do?
It’s interesting that Wikipedia lists over 90 cognitive biases. A term used to describe the many distortions in human thinking which lead to wrong perceptions or illogical conclusions.
Studies have shown that, even when warned about a bias beforehand it has little impact on our ability to avoid it. Remember the old adage of garbage in, garbage out (GIGO). So as you make your assumptions with your retirement planning tool be aware of these biases.
Anchoring – the common tendency to rely too heavily, or “anchor,” on one piece of information when making decisions. In a number of these tools we are given an example number which will be the basis of our “anchor”.
Confirmation Bias – the tendency to search for, or interpret, information in a way that confirms, rather than disproves one’s assumptions. So we fiddle with the variables until they match our preconceptions.
Wishful Thinking Bias – the formation of beliefs and the making of decisions according to what is pleasing to imagine instead of being based on evidence. The cumulative effect of this together with the optimism bias can lead to a euphoric conclusion.
Optimism Bias – the tendency to be over-optimistic about the outcome of planned actions. In this case there would be a tendency to estimate returns from investments too high and inflation too low.
Money Illusion – the tendency to concentrate on the face, or nominal, value of money rather than its value in terms of purchasing power. This is often used by financial institutions with their projections to create an illusion of the attractiveness of their proposal.
Positive Outcome Bias – the tendency to overestimate the probability of good things happening to us. We’ll have a a job, with an increasing salary till the end of our working life. Somehow our life will be fine. won’t it?
Retirement planning, like any planning, is not precise – so a simple retirement planning tool can work. Try wherever possible to eliminate your biases by getting other opinions and asking lots of questions.
Just because we cannot predict the future doesn’t mean that we must ignore it. There will be events that take place that no one could ever predict. Apply a good dose of your own thinking in evaluating them in relation to the tool, make adjustments and tweak the plan as changes happen..
In using a retirement planning tool we need the expertise and guidance of financial advisers to provide guidance and advice on the technical issues of tax and and the vagaries of our various retirement investments – that is, use them for the elements that they are experts in.
However in developing your long term scenario apply plenty of your own brain power. at least you may recognise your own biases.