Cognitive biases that can derail your retirement
Recency bias The tendency to attribute increased importance to events of the recent past.
Hindsight bias This is where past events seem more important than they did when they were occurring.
Anchoring bias The common human tendency to rely too heavily, or ‘anchor’ on one piece of information.
Loss aversion Our clear preference for avoiding losses over acquiring equivalent gains (fear is a greater motivator than greed).
Framing bias The way we react differently to a particular choice depending on if it’s presented (framed) as a loss or a gain.
Outcome bias This is where decisions are based on the past outcome of a process rather than the quality of the process itself.
Herding bias Our willingness to follow the crowd without feeling the need to make our own judgments.
Forget ‘black and white’
Unfortunately, although we might understand what influences our financial decision-making, this knowledge in itself doesn’t help us to make better decisions about how to invest our pension pots. This is because if, like the great majority of Britons approaching retirement these days, you’ll be relying on your pension pot to pay a decent level of income throughout your dotage, you simply can’t afford to ignore stock market investments.
Once you stop contributing to your pension and start drawing down a regular income, inflation immediately becomes one of the biggest threats to your hard-earned pot. To counter the effects of inflation you’ll need to invest a decent portion of your overall pot in assets such as equities, commodities or property that have historically beaten inflation over longer time frames.
Of course, the problem with risk assets, as we all know, is that they can go down as well as up.
If your portfolio starts to decline at the same time that you begin drawing a regular income from it, the impact of this ‘sequence of return risk’ can beach your pension pot long before you reach the end of your planned retirement.
With all this in mind, there are two things you’ll need to ensure you don’t fall into one of the many pitfalls awaiting retirees – whether they stem from our own psyches or not. The first is a qualified financial adviser who can explain all the options available and build a plan that’s best suited to your individual needs and level of risk tolerance.
The second is a professional fund manager who understands the crucial difference between how to invest for someone in the ‘accumulation’ stage of their pension planning and the ‘decumulation’ stage. If you can find the right adviser and the right fund manager, there’s no reason why your pension pot shouldn’t last for 40 years or more of retirement and still have something left to pass on to your nearest and dearest.
Of course, there’s nothing to prevent you from managing your pension pot yourself – just don’t let your natural biases paint you into a corner.
The value of pensions and the income they produce can fall as well as rise, you may get back less than you invested.
CA Financial Services provides advice only and does not provide a fund management service.
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