The study looks at two common biases that can affect how one saves for retirement — present bias, the tendency to put more value in current or short-term decisions than the future, and exponential-growth bias, aka, the tendency to underestimate and neglect the power of compounding investment returns.
“A person with present-biased preferences may intend to save more in the future but never do so,” the study states, adding, “a person with exponential-growth bias will underestimate the returns to savings and the costs of holding debt.”
As the Center for Retirement Research at Boston College points out, “this study helps us to understand why, as well as how much” our biases matter.
“The people who are not present biased had, on average, about 19 percent more in savings than those who value tradeoffs much differently over the short term and the long term,” the Center for Retirement Research said in an examination of the NBER study, The Role of Time Preferences and Exponential-Growth Bias in Retirement Savings. “Those who accurately perceived the power of compounding had about 20 percent more than those who neglect compounding completely.”
While behavioral biases’ effect on retirement savings have long been studied, this is the first study to establish a link between self-awareness of these biases and economic outcomes in retirement savings.
“It has been suggested that self-awareness regarding one’s biases may be as important or even more important in determining behavior than the direct effect of the bias itself,” according to the NBER study.
Being self-aware of one’s biases could lead to a 12 percent increase in overall retirement savings — or as much as a 70 percent increase using estimates that account for classical measurement error, the study finds. Translation: if you don’t check your investing biases at the investment door your retirement money could be a lot smaller — 70 percent smaller.
“Self-awareness has the potential to mitigate the impact of the biases,” the study states. “For instance, a person who is aware of her EGB could rely on the market to acquire tools or seek advice, and a sophisticated present-biased person could use commitment devices to control the impulses of her future selves.”