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October 05, 2005 at 08:00 PM
It’s no secret that baby boomers, those born between 1946 and 1964, are beginning to enter retirement. It is also no secret that a large percentage of them are financially unprepared. While there have been significant discussions about this challenge, few people–financial representatives among them–realize the heavy toll that emotion and human nature are taking on retirement planning.
The emerging field of behavioral finance, which seeks to understand and explain how emotions and long-held thought patterns influence investors and the decision-making process, can help to explain boomers’ investing behavior. The truth is that many boomers are in a state of financial paralysis. They don’t:
o know the ramifications associated with not saving.
o think they can save.
o recognize the opportunities that could help them get ahead of their peers, savings-wise;
o know how much to save;
o appreciate the urgency of starting now; and
o understand the basic financial principles–like compound interest and adequate returns.
Albert Einstein once said that the greatest power in the universe is compound interest. When it comes to saving for retirement, Einstein was right. Compound interest is crucial when preparing for retirement–the earlier you start saving, the more you’ll have down the road.
Research shows that many boomers don’t understand this concept. They lack urgency about saving for retirement because they don’t understand the value of starting retirement savings early.
According to “Beyond Behavior: Why Boomers Underfund Retirement,” a survey released by The Guardian Life Insurance Company of America, the majority of boomers erroneously believe that starting to save later in life, for a long period of time, is a more conservative approach than beginning early and saving for a shorter time frame. Of those surveyed, 76% reported that saving $100 per month from age 30 to 65 would yield greater returns than saving $100 per month from age 21 to 30.
The latter, however, is the real conservative saver.Even without putting away another dollar for the last 35 years, this individual would have a larger nest egg at age 65 because he/she gains the benefit of compound interest over time. (Note: this hypothetical example assumes a flat, positive rate of return throughout the stated periods.)
This finding, among other conclusions, clearly indicates that boomers need more education if they are going to meet their retirement needs and use practical strategies for putting more money away. In the next 15 years, more than 70 million Americans will enter into a state of retirement that may last several decades.
According to the Guardian survey, 80% of these individuals are concerned with outliving their income. Financial representatives can help provide the necessary guidance and quell the uncertainty that many boomers are experiencing.
One tool that representatives should consider recommending to boomer clients is annuities. Though most boomers are aware of annuities as an investment option, they usually don’t understand annuitization and its benefits. Some questions are:
