3 common saving and investing mistakes — and tips to start avoiding them

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The way our brains are programmed could get in the way of long-term savings goals.

Key points

  • The way you make decisions in other parts of your life could be undermining your choices when juggling retirement saving and other goals
  • You can avoid these decision-making pitfalls by refocusing on your goals and life priorities
  • Use our Set your goals and track your progress worksheet to review your financial priorities and align them with your longer-term goals, including investing for retirement
Even though they may have the best intentions, 40% of today's workers say their retirement savings goals will be either difficult to reach or virtually unattainable, according to a Merrill Edge research report.Footnote 1
But rather than blaming ourselves for the savings shortfall, we might be better served by acknowledging that our preprogrammed brains may be getting in the way of our progress, says Andrew Porter, director of behavioral finance, Merrill Lynch Wealth Management.
"The fact is that we're all human beings, not robots," Porter says. "Our brains are designed to follow certain predictable patterns that serve us well in everyday life, especially when our environment is complex or confusing." Where we get into trouble is when these patterns get in the way of making good decisions about saving for retirement when other financial goals compete.
Here are three common examples of how we can go astray.

1. Focusing more on the here and now than on what might lie ahead

As human beings we're wired to take care of immediate needs first, making sure that our essential requirements for food, shelter and security are met. So it's understandable that when current short-term financial goals compete for attention, saving for the future gets neglected.
In fact, says Porter, research has shown that people have great difficulty envisioning distant events as easily as events that are closer in time. This is known as the present bias. "In terms of competing goals, what's near is much more tangible," he says. "It's easier to picture and articulate. There is a lot more certainty associated with it." There's also a tendency for people to think sequentially and linearly about decisions and feel like what's next on the list is more important than decisions about what comes later. "From an evolutionary perspective, it makes complete sense because you want to survive moment to moment," he explains.
When it comes to investing, we all have difficulty understanding the value of time.
In addition to the tendency to focus on the present and think linearly, there may be other very human behaviors at work that can derail longer-term savings, says Porter. "The availability bias, for example, is a mental shortcut where people rely more heavily on the information that first comes to mind when making decisions," he says. As a result, we may put more value on the easily available solution rather than on one that could be more appropriate but is harder to find.
This might cause people to save and invest for their family's educational goals first, rather than retirement. "The fact that educational goals can impact many family members at once may make that goal not just closer in time, but more top of mind relative to a retirement goal that appears to affect only the saver/investor," Porter explains.
Other goals like this may include buying a car or house or going on a vacation — all of which may feel more pressing than retirement. "But are they all ultimately as important as retirement?" he asks.
What can you do to overcome it?
Think in terms of your most important life priorities and goals when you make financial decisions.
Temper the all-too-human focus on the present when trying to manage competing financial priorities. The solution may be as simple as asking yourself if the financial priorities you're focusing on now are really the most important ones given your overall life goals.
Porter suggests five steps to help you do this:
  1. Write down your concerns, needs and goals in a document that you intend to keep and revisit.
  2. Prioritize those concerns, needs and goals according to what is most important to least important to address in your life.
  3. Make a plan that aligns your investment decisions and money behaviors to the most important goal first, then go down the list. (It doesn't have to be done all at once.)
  4. Share the plan with another person (spouse, partner, child, etc.). "That will help you stick to your plan," he says.
  5. Revisit your progress toward your goals regularly and make appropriate trade-offs to get there. To help you review your progress on these steps, see the Set your goals and track your progress worksheet.

2. Underestimating the real cost of waiting to save and invest

In addition to thinking in a linear fashion, we also have difficulty understanding the value of time when it comes to investing, says Porter. In fact, a research study in 2011 found that people discounted the importance of saving today versus waiting until later because they were unaware of the true value of what exponential growth really meant.Footnote 2
"Due to compound interest, savings can grow exponentially over time. But most of our participants believed that savings grew linearly, and they therefore grossly underestimated how much money they could actually accumulate over the span of a typical career," says Porter. They also underestimated the cost of waiting to save, making the decision to put off saving and investing less onerous than it ought to be, he says.
The power of compounding — how investing early may increase returns over time
At age 25, Karen starts contributing $200 a month to a tax-deferred retirement account. She increases her contribution by 3% each year and earns 6% annual interest. By age 65, Karen's account has grown to $639,600.
Compare this to her friend Jennifer who tries to make up for lost time by contributing $300 a month to her retirement account starting at age 35. She also increases her contribution 3% each year and earns 6% annual interest. However, by age 65, Jennifer's account reaches only $456,300 — $183,300 less than the value of Karen's account because it has had less time to grow through compounding.
Graph showing the power of compounding interest by using examples of two investors who begin investing at ages 25 and 35.
This is a hypothetical example and does not represent the performance of a particular investment. Scenarios assume a 3% increase in contribution each year and an average annual return of 6%. Actual results will vary. Actual investing includes fees and other expenses that may result in lower returns than this hypothetical example.
Source: Merrill Lynch Wealth Management, 2019.
In the end, Porter says, participants realized that the benefits of saving early with the possibility of earning more compound interest were surprisingly large and it would be very difficult to make up for lost time later.
What can you do to overcome it?
Use a calculator to help you "do the math" and identify the best way forward based on your goals.
See how different time periods, payment amounts and assumed interest rates can affect the amount you can save over time through compounding by checking out the Compound Interest Calculator from the U.S. Securities and Exchange Commission.
To see how saving and investing even a little more today can affect the amount of retirement savings you can accumulate for the future due to compound interest, use the Merrill Edge® Personal Retirement Calculator and try different contribution amounts and time periods.

3. Getting emotionally attached to a decision

When trying to reconcile financial priorities that compete with retirement, "what many people say they struggle with the most is their desire to give more to their families than they can actually afford," says Porter. In this context, "giving" is referring to not just leaving a legacy at the end of life, but to all the giving that parents may do throughout their lives, he says.
For many parents, for example, long-held beliefs about paying for all of a child's secondary school or college education, buying them luxury clothing when they are teens and supporting their lifestyle when they're adults are all forms of what behavioral finance experts call the endowment effect.
"We use the endowment effect as shorthand to describe the difficulty involved in letting go of closely held, emotionally charged goals in place of things that we know are more important for the long term — like health care or retirement," says Porter. The endowment effect doesn't need to be related to a tangible asset, like a home, that you have strong attachment to. Again, it could be a deeply held belief that you should pay for your children's entire education or your desire to give them a better life than you had.
The endowment effect is closely aligned with the concept of loss aversion, since giving up long-held beliefs is extremely difficult. "When you are giving up something that you value highly, the loss can feel terrible," Porter says. Research has also shown that losing something of value feels twice as bad as gaining something of equal value.
What can you do to overcome it?
Reframe your thinking around a new set of priorities.
Because the desire to give and the aversion to loss are such emotionally charged behaviors, "getting to a place where you can overcome these natural inclinations by reframing the glass as half full rather than half empty is critical," says Porter.
A key part of the reframing process is to honestly assess your situation according to your current goals and priorities, he says. The Set your goals and track your progress worksheet can help you begin a more realistic exploration of what's important to you.
When you start looking at your financial priorities through a new lens, the decision to forgo something less critical in favor of saving for a longer-term retirement goal may not be as much of a sacrifice, says Porter.
Trying to tackle competing long- and short-term financial goals is never simple. But just recognizing how some of your preprogrammed behaviors may be affecting your decision-making could be enough to help you overcome their influence and modify your investment strategy to reflect what's really important to you.
Next steps

Footnote 1 Merrill Edge® Report Fall 2016.

Footnote 2 McKenzie, C., M. Liersch. 2011. Misunderstanding Savings Growth: Implications for Retirement Savings Behavior, Journal of Marketing Research

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