Researchers have been digging into the psychology of saving.

What they’ve discovered can be useful as you sort through your finances.

A recent study from UCLA and Microsoft Research found that how we think about money can affect how we save for retirement. It can also impact how we draw down savings once we’re in retirement. In particular, we may view lump sums very differently than monthly sums, even if they are about the same amount. Researchers call this phenomenon the “illusion of wealth” and the “illusion of poverty.”1

To understand this difference in perception, the researchers presented people with the following situation:

  • Pretend you have $1 million in your bank account for retirement.
  • Then rate on a scale of one to seven how adequate that amount seems — one being “totally inadequate” and seven being “totally adequate.”
  • Next, pretend you have $5,000 each month of retirement. Rank the adequacy of that amount.2

What did you rate the two scenarios?

The amounts come out to be roughly the same,3 but the researchers found a distinct difference in how people felt about the lump sum versus the monthly sum.

The illusion of poverty.

Investors who felt that $5,000 a month was more comfortable than a $1 million lump sum identified with the illusion of poverty. The study explains that investors with this mindset tend to think about wealth in terms of monthly income, which can lead to them worrying that they’ll run out of money. To combat this, they tend to shift their lifestyle instead of living the life they can actually afford.4

The illusion of wealth.

Then there are investors who felt that $1 million was more comfortable than the monthly $5,000. These people leaned toward the illusion of wealth. This mindset can lead to under-saving for retirement because that seemingly large sum of money can give these people a false sense of security.5

What this means for you.

How did you rate the two scenarios? Being aware of misperceptions you might have is a great first step in bolstering your retirement savings strategy. It can also help keep you from making sure you aren’t inadvertently pulling the wool over your own eyes. Help set yourself up for success by figuring out how you think about money and what kind of saver you are. Then use that information to develop saving strategies to keep your psyche and emotions in check.

 

1 (2016 October). The Illusion of Wealth and Its Reversal. AMA Journal. Retrieved on May 22, 2017 from http://journals.ama.org/doi/abs/10.1509/jmr.14.0652?code=amma-site
2, 3, 4, 5 Benartzi, S. and Hershfield, H. (27 March 2017). Would You Rather Have $1 Million or $5,000 Monthly in Retirement. The Wall Street Journal. Retrieved on May 22, 2017 from https://www.wsj.com/articles/would-you-rather-have-1-million-or-5-000-monthly-in-retirement-1490582208
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