How Behavioral Factors Shape Retirement Wealth
A recent Wharton conference explored how noncognitive skills,
mortality beliefs, aging, and gender disparities impact retirement wealth.
Wharton’s Olivia S. Mitchell states the stark truth about saving: “Let’s be honest, saving is no fun. People don’t get ‘utils’ (or utility) out of saving. They get utils out of spending. Therefore we must devise new ways to make saving more enjoyable.”
Retirees can get those utils if their savings, including pensions or annuities, are sufficient to finance their lifestyle and health needs. Much depends, of course, on how wisely they saved and invested pre-retirement, as well as their spending patterns in retirement. Driving all that are several behavioral factors, which a recent Wharton conference explored.
About 30 experts delved into these and more topics at the 2024 Pension Research Council symposium, titled “Retirement Saving, Investment, and Spending: New Lessons from Behavioral Research.” Mitchell, a professor of business economics and public policy as well as executive director of the Council, joined Wharton finance professor Nikolai Roussanov to host the two-day event, which marked the Council’s 70th anniversary.
The symposium explored key behavioral factors impacting retirement wealth creation, including conscientiousness and emotional stability, how long people expect to live, how much they expect to spend in retirement, and the decline of cognitive skills with advancing age. Other factors include gender differences placing women at a disadvantage in their wherewithal to save, and shortcomings in retirement plan design.
Knowledge of retirement saving opportunities, along with financial literacy and numeracy, are, of course, prerequisites for retirement preparedness, but they are not enough. Noncognitive skills — soft personality traits like conscientiousness, stress resistance, grit, and locus of control (people’s beliefs about the extent to which they can control events in their lives) — also impact retirement readiness, according to Kim Peijnenburg, a professor at the EDHEC Business School in Nice, France.
Conscientiousness reflects the tendency to be organized, practical, persistent, self-disciplined, and achievement-oriented. It is the most important of the “Big Five” personality traits affecting financial decisions, Peijnenburg noted. The other four are openness to experience, extroversion, agreeableness, and neuroticism.
Peijnenburg and EDHEC colleague Gianpaolo Parise reported that those with high conscientiousness plan systematically for retirement, and they also have more financial wealth than those at the other end of the spectrum. Their study included 13,145 individuals in the Netherlands, between 2008 and 2017.
The top finding was that people in the lowest quintile of emotional stability had a 10% higher probability of being in financial distress, such as being irregular with mortgage payments or rent or utility bills. By contrast, those in the highest quintile of conscientiousness and emotional stability had only a 1% probability of being in financial distress.
Mortality Beliefs and Suboptimal Savings
People’s perceptions of their own longevity also have implications for their retirement planning. According to Arizona State University finance professor Rawley Z. Heimer, many underestimate how long they will live when they are young, which leads them to consume and spend recklessly, save less, and make suboptimal decisions for retirement planning. But as they get older, they overestimate their lifespans, rein in spending, and go slow on drawing down their retirement assets. Somewhere between those two states, they realize they haven’t saved enough for retirement and start to invest more in stocks.
People who lean toward subjective beliefs tend to have incorrect forecasts about several economic variables, such as housing prices, stock market returns, and their own employment. Those who rely on actuarial probabilities — an objective approach — might save more for retirement, he noted.
The Role of “Others” in Retirement Saving
Neighbors, peers, family members, coworkers, and financial advisors also shape how much people save for retirement. Michael Haliossos, chair of microeconomics and finance at Goethe University in Frankfurt, shared his research findings exploring how “others” help boost wealth accumulation.
One of his projects studied neighbors’ peer effects, using data from a Swedish refugee allocation program between 1987 and 1991. The authors tracked participants for the next 10-20 years to identify outcomes in private retirement accounts and stockholding. The top finding was that having more neighbors with college-level economics or business education promoted immigrants’ retirement saving. Another finding was that refugees with a high school certificate and who had neighbors with degrees in business and economics were more likely to be participating in private retirement accounts and hold stock over the next 10 to 15 years.
A second project studied the effects of greater local wealth inequality on people’s later wealth mobility. In such a setting, college-educated households took on more asset risks later in life, such as investing in stocks, housing, and self-employment. Thus, they achieved greater wealth, whereas others who were not similarly motivated were left behind. The implication of those findings is that policymakers need to find ways to empower less-educated households in their financial behavior, Haliossos said.
A different project compared advice on the share of risky assets in retirement saving portfolios given by professional financial advisors with advice provided by lay advisors, such as family and peers. He found that professional advisors tended to recommend a lower allocation to risky assets for retirement than lay advisors. Also, professional advisors were influenced by their own income, age, risk aversion, and risk exposure in their own portfolios, when they offered clients advice. The final study looked at the effects on financial behavior of stress caused by events like the COVID crisis, a financial crisis, or a war. This study showed that such cognitive loads preoccupy one’s mind, draining people’s ability to concentrate and perform important tasks.
The Real Drivers of the Gender Gap in Wealth Creation
Behavioral factors also influence opportunities women get to save for retirement, compared to those for men. Motherhood and caregiving burdens mean that women have fewer years than men in the paid workforce, lower income trajectories, and a higher incidence of part-time work, said Vickie Bajtelsmit, professor emerita of finance at Colorado State University, who has researched the gender gap in retirement saving.
Consequently, women are penalized both in their employer retirement plans and in Social Security. Segregation also reduces their opportunities to earn and save: The top occupations for women remain teaching, nursing, retailing, and social work, Bajtelsmit noted.
Although conventional wisdom holds that women are more conservative investors than men, Bajtelsmit said that this is an incomplete story. Instead, their lower retirement wealth is mainly due to gender differences in labor markets and household responsibilities. For this reason, solutions to bridge the gender wealth gap must also focus on the labor market and lifelong financial literacy education. Solutions could include continued pressure on the gender pay gap, providing women with broader retirement plan access, and prorated benefits for part-time work, she said.
How Aging Affects Financial and Health Decisions
Older Americans face yet another set of challenges, including mild to severe cognitive impairments that affect their abilities to make financial and health decisions. These impact Social Security claiming choices and end-of-life transfers of wealth. At the same time, many people lose important resources such as social networks and community interactions as they age. Aging is also associated with losing loved ones, including their spouses, friends, and people of the same age.
Such cognitive, contextual, and psychosocial variables are key determinants of decision-making ability, according to Patricia Boyle, professor of behavioral sciences and neuropsychology at the Rush Alzheimer’s Disease Center in Chicago, and Gary Mottola, research director for the FINRA Investor Education Foundation. They shared findings from the Rush Memory and Aging Project, which has tracked about 4,000 older adults from the Chicago area annually since 1987.
Difficulties in making financial choices and understanding the factors at play seem to be an indicator of adverse health outcomes to come, Boyle noted. Someone who has trouble with difficult choices is more likely to develop dementia, for example, or go on to develop more cognitive problems over time, she said.
One finding of the Rush project is that lower levels of cognition are related to lower levels of financial and health decision-making. Another finding was that low levels of financial and health literacy were related to low levels of decision-making. The rate of decline in those levels was related to scam susceptibility and psychological well-being.
In one experiment, the authors gauged how participants responded to a scam offer. The participants received emails, direct mail, and phone calls from a fraudulent marketing campaign conducted by a fictitious agency called the U.S. Retirement Protection Task Force. They were told that their retirement savings accounts had been hacked, and that the task force wanted the last four digits of their Social Security numbers.
Most of the roughly 650 participants (69%) did not engage with the campaign. Some were skeptical (15%); they spoke to the fraudster, asked questions, and sometimes berated him, Mottola said. Nevertheless, 16% of the participants fully engaged with the campaign, providing the information requested without skepticism, although not all revealed their Social Security numbers. None of those calls were recorded, nor did the fraudsters use high-pressure tactics.
The key takeaway here was that 16% number was too high, Mottola said. The full engagement group had the lowest levels of financial literacy and lowest levels of scam awareness. The skeptical engagement group had the highest cognition, which he noted was surprising.
How “Undersum Bias” Hurts Retirement Saving
Many people also underestimate how much money they need to retire comfortably, or the probability of unanticipated expenses, said Shane Timmons, a senior research officer at the Economic and Social Research Institute in Dublin. He documented an “undersum bias” (a term coined by University of Buffalo marketing professor Indranil Goswami) that led people to be less financially prepared for retirement.
Timmons shared highlights from work that he and University of Galway lecturer Féidhlim McGowan conducted on undersum bias and the various ways in which it plays out. He noted that undersum bias occurs when people do not fully comprehend concepts like compound interest, and as a result, underestimate how money can accumulate. They also underestimate the probability of unexpected financial shocks and, therefore, put aside less money than what they need for emergency expenses. Additionally, they underestimate the accumulated impact of several financial shocks, which implies that this bias is an impediment to precautionary saving.
Interventions can help, Timmons and Galway found. They used a “nudge and boost” communication tactic to encourage participants to open savings accounts. That led to a larger-than-expected increase in saving account uptake (over 25%); it was especially helpful for the lower-income sample. They also showed that simple infographics explaining the cumulative probability of financial shocks can also motivate a saving habit.
All said, pushing people to save more may not always be the best approach. Accordingly, Mitchell speculated that it could be unwise in some cases to incentivize the poor to save more. That is, some low-wage workers might do better to pay bills and feed their children, in view of the 90% replacement of pre-retirement income that Social Security will pay, she noted.