When helping clients plan for retirement, for exiting their business or for reaching other major financial goals, we tend to default to the numbers. Financial projections, spending needs, drawdown rates and risk tolerance are great navigational aids.
In the fast-evolving field of behavioral finance, research shows that understanding clients' emotional relationship with money is just as important as the numbers. And a new approach is showing that getting in tune with our future selves is one of the best ways for clients and their advisor to plan for retirement.
It's not easy imagining what life will be like for us 10, 20 or even 30 years from now. And it's even harder to imagine when you consider that we change more than we'd think later in life. Harvard psychology professor Dan Gilbert has done extensive research in this area in what is called "
According to his research, which involved thousands of people aged 18 to 68, the illusion persists from teenage years into retirement. As expected, younger people reported more change in the previous decade than did the older respondents. But when asked to predict what their personalities and tastes would be like in 10 years, people of all ages consistently played down the potential changes ahead.
As a result, we have to keep adjusting our goals, including around retirement planning, and that comes by getting well acquainted with our future selves, according to Hal Hershfield, professor of marketing, behavioral decision-making and psychology at UCLA Anderson School of Management. Hershfield has spent most of his career straddling psychology and financial decision-making. He said it's important to consider the goals for yourself when it comes to money and saving, but also the goals you have for your future self after you have stopped earning an income.
Hershfield told me on
Not everyone is wired the same way, of course. Researchers found that people whose temporal parietal junction of their brain is turned off, or repressed relative to other parts of the brain, tend to score lower on numerous aspects of social cognition, such as cognitive empathy and perspective-taking, including diminished ability to empathize with their future selves.
Further, they are more likely to exhibit impatience and are more likely to choose an immediate reward than wait for a greater reward down the road. I'm not suggesting financial advisors have neuroimaging equipment installed at their offices, but they need to do a better job of understanding the emotional and psychological aspects of a client's financial behavior in ways that a compound interest chart can't.
Hershfield, author of "
Hershfield said another principle of behavioral finance is that it's totally rational to discount future rewards for immediate gratification.
For example, If I'm offering you $100 now or $100 in two weeks, you're going to take the $100 right now. But if I offered you $100 now or $125 in two weeks, most rational people would wait for two weeks. But some people would still take the $100 now even though they know that waiting until later offers a much better return. Regardless of financial circumstances, folks who can't delay gratification may have issues with impulse control, or simply feel there's so much uncertainty in life, that they don't want to risk losing the sure $100 by waiting for more money down the road.
That can unlock lots of clues to a client's relationship with money and how to plan around that. Hershfield said it goes back to basic evolution and our innate survival instincts.
Hershfield also told me about a phenomenon called "preference reversal" in which people are fairly patient when it comes to financial goals that are, say, three months down the road, but then become extremely impatient and irrational as they get very close to the realization date.
That seemingly irrational behavior helps explain why many people are tempted to derail their retirement plans when the markets are going crazy shortly before their retirement date.
From where I sit, behavioral finance is evolving to show the wisdom of having some flexibility as you plan for the future. You must revisit your plans and update them as your values, goals and circumstances change.
According to Hershfield, negotiating with yourself is tough because our future selves have no voice at the table. It turns out we can be very unfair to our future selves. "If I think that I won't change in some way, I may make plans now that I'll later regret because I didn't offer up enough flexibility," said Hershfield, "and that's also problematic."
Not only do we not know our future selves well, but algorithms and the law of averages can often be better predictors of our future selves than our own minds. Hershfield said that important existential questions such as: "At what age should I retire?" or, "What should my retirement life look like?" can often be answered better by looking at thousands of other people who have gone through these decisions before, than by contemplating them yourself. That's where a skilled advisor who has behavioral financial training can be a huge ally.
Of course, constantly deferring to your future self and delaying gratification can go too far. Hershfield said it's like having a gift card to a restaurant that you keep holding onto waiting for the perfect occasion and then the restaurant closes before you can use it. When you're thinking too much about the future and not living in the present, you can end up "screwing your future self over" because you're not having any experiences and memories, or you're having only impoverished ones to look back upon.
According to financial advisor Paul Fenner, it's not just about balance, but about harmony between present and future selves. It's about making sure that both your current self and your future self have a voice at the negotiation table.
For more about tapping into your clients' relationship with money, check out my
