Understanding — and overcoming — your clients’ behavioral biases

The following is an excerpt from a new white paper, “The road to retirement success”, which was co-developed by the InvestmentNews Content Strategy Studio and Great-West Financial®. To view download the full white paper, click here.

Building a retirement nest egg and insuring adequate retirement income are key challenges for mass affluent investors.

Whether they are in their forties, fifties or sixties, fewer will enjoy the security of a traditional, defined benefit pension, and making up for the loss of that retirement income stream is difficult. At best, returns on bank savings accounts and fixed-income investments have barely kept pace with inflation. Saving more during working years to create larger nest eggs is an obvious solution, but doing that is easier said than done when middle-class incomes are stagnant, jobs can be precarious and the cost of higher education takes a larger and larger bite of income. A singular focus on saving more may be unrealistic and demoralizing.

Doing the right thing on many fronts is how many mass affluent investors — hopefully with the assistance of professional advisors — must now approach retirement. That means giving serious consideration to how and when to leave the full-time workforce, when to claim Social Security and how to manage living expenses, including ways to deploy home equity.
For advisors, running the numbers is the easy part. The calculations required to determine how much accumulated capital is necessary to generate a particular level of future income are widely available and require just a few assumptions about interest rates and returns to produce a result. The hard part is helping clients make lifestyle choices and tradeoffs and deal with the many emotions that spring from those calculations and decisions. The tension could be called the “million-dollar challenge.”

Let’s use a specific example to illustrate the point. Assume a client couple has a $1 million nest egg, consisting of 401(k) account balances, IRAs, Roth IRAs, non-qualified accounts and bank savings. Tens of thousands of advisors might consider such a couple typical of their clients, even though that level of wealth would make the couple unusual among the general population since half of U.S. households have no retirement savings at all and around 29% of households age 55 and older have neither retirement savings nor a pension.1 It’s no wonder, therefore, that any client who has amassed a nest egg of $1 million is not only likely to feel proud, but also fairly affluent. And since the Census Bureau estimates that the median net worth excluding home equity for an American in the 55-64 age range is $45,447, on a relative basis such a person or household could be considered wealthy.

But in terms of its income-generating ability, $1 million is not an enormous sum. Using as a guideline the time-honored 4% rule developed by financial planner William Bengen, such a nest egg could produce approximately $40,000 a year in income before taxes — not insignificant, to be sure, but hardly what one might think of as supportive of a millionaire’s lifestyle.

While advisors can easily explain the math, the challenge is understanding and working through the client emotions. Some may be euphoric about having attained millionaire status and ignore the income side of the equation, presenting one set of challenges. Other clients may dwell on the relatively modest income that $1 million is likely to produce and feel anxious and depressed, perhaps paralyzing any decision-making. Others may feel excited by the prospect of making changes that could increase retirement income.

The confusion and swirl of emotions that surround the nest egg/income issue is repeated in countless other areas and in many investment decisions. And while experience shows that investor education helps encourage clearer decision-making, those efforts alone are not sufficient to change behaviors that can lead to better outcomes.

To view download the full white paper, click here.

¹ The source is the Government Accountability Office and the GAO Analysis of 2013 Survey of Consumer Finances Data at https://www.gao.gov/assets/680/670153.pdf