Investment Decision-Making: How to Plan for Retirement

Warren Buffet famously said, “Investing is simple, but not easy.” And unsurprisingly, he's spot on—while investing is just a math problem, it’s not one most people are equipped to solve.

Take the state of retirement accounts as proof. In a report using the new Morningstar Model of US Retirement Outcomes, our analysts—Spencer Look and Jack VanDerhei—examined the likelihood that today’s US workers will have adequate financial resources in retirement. Their findings may be alarming: About 45% of Americans will experience retirement-funding shortfalls. In other words, nearly half of Americans will run out of money in retirement.

Although there are many reasons for this reality, we cannot ignore that investor decision-making plays a role. If we want to truly help investors reach their retirement goals, they’ll need more support and guidance to make appropriate investment decisions tailored to their financial situation.

Investors must overcome three overarching and overlapping obstacles:

• Closing gaps in expertise
  Most investors don’t have the background or expertise necessary to tackle modern portfolio theory or to wade through the complexity of the financial industry like tax consequences, investment types, and risk considerations. And when investors want to personalize their investment decisions, they add further complexity as their situations can affect factors such as how much to be saving for retirement.

• Preparing for the unknown
  To prepare for an unpredictable future, investors must make choices that position them to withstand a multitude of both market and personal scenarios. This means investors need to ask themselves questions like, “What will my future health costs be?,” “How long will I live?,” and “What other unexpected expenses should I prepare for?” At the same time, people can be poor forecasters and struggle to make meaningful predictions about the probabilities of different outcomes, which sets them up to fail.

• Managing behavioral biases
  It’s no secret investors face numerous biases and decision-making obstacles when making investment decisions—in short, long-term investing feels unnatural. The human brain encourages people to chase after returns, follow the crowd when everyone is selling, and make decisions for today rather than tomorrow. These impulses can spell trouble as they often encourage unwise investment decisions (like buying a hot stock at its high).

Altogether, these factors make investing decisions an uphill battle for investors.

Investing decisions aren’t easy, but investors have several resources and tools to help guide their process.

Here are pros and cons of three common approaches:

We live in a time of seemingly unlimited information and tools to put that information to use. In theory, any investor has the ability to conduct extensive investment research, consider the complexities of their personal situation, and then execute an investment strategy to invest like Buffet.

But in reality, this option requires a great amount of time, skill, and perseverance that isn’t realistic for most investors. In fact, investors can be overwhelmed by the perception of limitless information to the point where it turns into information overload. Even if an investor overcomes these obstacles, they still can fall victim to investing and decision-making biases—making it hard to stick to their plan.

Investors can also choose to stick to the default investments and savings rate (if available) in their investment accounts. Employer-sponsored plans, for example, automatically enroll participants into a target date fund and set savings rate—helping to jumpstart saving and portfolio diversification. This default option also helps remove many of the biases and obstacles involved in investment decisions.

However, investors who use this strategy will only receive a general investment portfolio—one that won’t account for their personal financial situation such as whether they have a pension, company stock, or concerns about future long-term care costs. Given this option doesn’t do much to consider a holistic financial life, investors may be left unsure about issues like whether they’re saving enough or when they should retire.

Managed accounts, like Morningstar Retirement Manager, may be affordable services that give investment advice tailored to a person’s financial situation. Investors can use these services to help them determine the impact of big issues such as whether an annuity makes sense for their retirement needs or the optimal age to start social security benefits. While these programs provide personalized advice at an accessible price point, they're limited in the breadth and depth of personalized advice they offer by the financial information available to them.

Thus, some investors may find working one-on-one with a financial advisor beneficial despite the higher cost, as a close relationship enables the most personalized plan and ongoing, holistic financial advice. Investors working with advisors also benefit as they’re more likely to avoid biases while making investment selections throughout their financial lives. Investors can help manage their emotions and keep shortcuts from getting the better of them by passing off some of the decision-making to professionals.

Amid a changing landscape, today’s investors continue to face different obstacles and challenges. Despite a wide range of tools and information, investors may still struggle to take clear steps toward their financial goals.

Luckily, investors now have a few options—with variation in decision-making support, personalization, and cost—to help improve their chances of making good investment decisions. With the support of managed accounts, they can also receive personalized advice to help them on their retirement journey.