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By Christine Benz and David Blanchett | 07-22-2013 02:00 PM

Traps in Building Wealth for Retirement

Morningstar's David Blanchett examines how aversion to save while younger, fear of loss, performance-chasing, and high ownership in employer stock are problematic areas for retirement accumulators.

Christine Benz: Hi, I am Christine Benz for Morningstar.com. Behavioral pitfalls can affect investors at all life stages, including when they are accumulating assets for retirement. Joining me to discuss some of the key ones is David Blanchett. He is head of retirement research for Morningstar.

David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: David, you've provided a list of some of the key aspects of retirement planning that can be problematic from a behavioral perspective. Let's start with a couple of them. One is called hyperbolic discounting. Let's talk about what that means and how that affects retirement planning.

Blanchett: Well, hyperbolic discounting is this notion that people value kind of consuming today much more than tomorrow. They kind of think of the future is some far-off place, and so it doesn't work for them to kind to save for retirement. They have this kind of incredibly high discount rate. So, someone who is thinking about saving for retirement, well, that's 30 years from now, and that just seems a lot less real than going out and buying that new iPad today. And so the kind of the discount rates required to actually make people save sometimes can be relatively extreme.

Benz: Do you find that this is a bigger problem for people who are earlier in the accumulation phase and people maybe who are getting closer to retirement, or is it across the board a problem?

Blanchett: I think this focus on the cost of saving and kind of the rate of return you are required to earn kind of decreases over time. I mean, think of it as trying to talk a 10-year-old out of buying a truck with some new money that just came in to you. Now, kind of the older you are, I think the better people become at realizing, "Hey, I need to kind of save for retirement." And so, I think things like time preference just kind of do become less of an issue over time.

Benz: You've provided a couple of other terms that fall under this heading of problematic areas for accumulators. One is, something you call bounded self-control; the other is called inertia. Let's talk about how those two issues affect people when they are in the accumulation mode?

Blanchett: Sure. I'm a great example of bounded self-control. If someone were to buy me a piece of chocolate cake and put it in front of me, I'd probably eat it for dessert. And so I know that I kind of lack self-control, and so I don't order a chocolate cake for desert. And that same kind of concept applies to people saving for retirement. People want to save for retirement, but they just don't. I mean they know that it's the right thing to do, but they just can't bring themselves to do.

And that kind of ties into inertia. Inertia is the concept you know an object in motion can stay in motion. And so once you've kind of started not saving for retirement, so once you kind of entered the 401(k) plan or you chose not to and you are getting this paycheck, it's kind of easier to stay on that course than make a change. And this is why I think it's so important to make smart decisions early, so you get used to doing the right thing that comes to saving for retirement.

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