Study: Eliminating Behavioral Biases Could Boost Retirement Savings

By Nevin Adams • April 08, 2016 • 0 Comments
A new study suggests that if we could overcome certain behavioral tendencies, we could increase retirement savings by at least 12% — and perhaps quite a bit more.

In “The Role of Time Preferences and Exponential-Growth Bias in Retirement Savings,” a team of academics examined two specific behavioral aspects:

  • present bias (the tendency to value things in the present over the future in what the researchers called a “dynamically inconsistent way”); and
  • “exponential-growth” (EG) bias (the tendency to neglect or underestimate the benefits of compounding).
The researchers maintain that these factors, and the long-run discount factor, are all highly significant in predicting retirement savings, even when controlling for measures of IQ and general financial literacy. Additionally, they found that the effects are even worse (specifically, it has “an additional independent negative impact on retirement savings”) when individuals are unaware of their biases.

Behavioral Inclinations

The paper says that people with present-biased preferences may intend to save more in the future but never do so. Moreover, they may procrastinate on the decision to enroll in a tax-deferred savings plan, also resulting in lower savings. Those with EG bias will underestimate the returns to savings and the costs of holding debt, according to the report.

How many people are we talking about? While the researchers found that, on average, the population is time-consistent, what they termed as a “large fraction” are present-biased. Moreover, drawing on and replicating previous research, they claim that a “large fraction of the population” also exhibits EG bias.

As is the case with a lot of behavioral science research, most of their findings were based on what people would do, or say they would do, in hypothetical situations. Even when the situations were “real,” it was about trade-offs that didn’t actually affect how much people were saving — just their expressed tendencies. That doesn’t mean the findings are invalid, of course, just that we all know that sometimes what people say they would do they don’t always do when presented with the real situation.

Nonetheless, the researchers conclude that eliminating both present bias and EG bias from their study sample would lead to a 12% increase in overall retirement savings. Moreover, they maintain that the “regression coefficients are likely to understate the true association between retirement savings, time preferences and EG bias due to attenuation bias by measurement error” (a fancy way of saying the 12% is a conservative read). And therefore, “after employing an instrumental variables strategy to correct for classical measurement error, a causal interpretation of our estimates suggests retirement wealth could increase by “as much as 70% if [present bias and EG bias] were eliminated.”

Now we just have to figure out how to go about eliminating those factors…