Saving money for retirement is no easy task and you don’t need a financial expert to tell you that. The question is, what is the trouble with saving? According to behavioral economists, there are four inherent psychological factors that can answer this question.
The 4 Psychological Principles that keep people from saving are:
1. Many people have the desire to save more, but lack the will-power to do so.
2. It is easier to accept restrictions if they take effect in the future. This explains why we all procrastinate and plan on saving next year instead of starting now.
3. People are more sensitive to losses than to gains. Money saved is a perceived loss to a lot of us because it can’t give instant gratification to what we want now.
4. People have the inclination to think in nominal rather than in real dollars. This is called the “money illusion”. A pay increase even if it’s less than the rate of inflation is recognized as a gain. So people fail to realize that the cost of living is increasing faster than their income.
The “Save More Tomorrow” Strategy
With these psychological principles, economists Richard H. Thaler and Shlomo Benartzi came up with an innovative retirement savings plan called “Save More Tomorrow”. It works by inviting workers to participate in a future savings plan that will begin in their next scheduled pay raise. When they get their raise, some of it will automatically go to their 401(k) contributions. It is a good thing because they don’t feel a drop in their wages but they’re actually saving more.
Let’s say you are in your mid 30s, planning a retirement at 65 with 0 dollars in your 401(k). You have a median household income of approximately $50,000 with a 3% pay raise each year. Should you contribute just two thirds of your raise to your 401(k), by the time you retire you will have accumulated a rough 1.5 million dollars.
Save More Tomorrow can be applied to all of your unexpected income. Why not stash a percentage of your extra cash from bonuses, tax refunds and other free-lance income into your retirement savings? Anyway it wouldn’t hurt to set aside money you’ve lived without in the first place.
Every penny you save counts. No matter how small it is, it has the power to build up. When you begin to see results, you will realize how addictive saving can get. You will get all fired up and geared towards saving aggressively. Then, the journey towards your retirement bliss begins.