Just how much do biases affect retirement savings? According to a study, “The Role of Time Preferences and Exponential-Growth Bias in Retirement Savings,” present bias and exponential-growth bias in particular can wreak havoc on future funds.
Present bias is the tendency to focus on the present rather than the future, while exponential-growth bias, the tendency to neglect compounding investment returns. People who have present bias may mean to save more for the future but never do, or they may procrastinate enrolling in a tax-deferred savings plan. A person with exponential-growth bias tends to underestimate the returns on savings and the costs of having debt. Those unaware of these biases tend to save less money for retirement, the study found.
If biases are eliminated, however, it can result in a retirement savings increase anywhere from 12% to 70%.
Researchers from Stanford University, the London School of Economics and Political Science, the University of Minnesota and Claremont Graduate University tested the association between a direct measure of self-awareness about these forms of bias and the economic outcomes they cause.
As part of the study, the researchers asked respondents questions including whether (and, if so, when) they would be willing to complete an hour of paperwork to change their retirement plan based on their company’s new matching contribution; they would also get a $50 bonus for completing the paperwork.
Researchers found that if they gave a deadline for completing the paperwork, it increased the chances that respondents would change their contributions by 8.3 percentage points. If they didn’t give a deadline and just provided a cash incentive, the chances increased by only 4.3 percentage points.
The survey also asked questions about the value of an asset. For example, what would the value of an asset be after 20 periods if it experienced growth at an interest rate of 10% each period? The study found that overconfidence regarding exponential estimation has an additional negative effect on retirement savings.
Present bias and exponential-growth bias therefore have a profound effect on an individual’s retirement savings, the study concluded.
The full study report can be downloaded here.