Don’t let your brain get in the way of a good retirement

We came across this article written by Simon Russell, a director of Behavioural Finance Australia and we wanted to share it with you.


A 50 per cent chance of winning $100 or losing $10 sounds like a pretty good bet, right? With an expected outcome of $45, rational gamblers would take odds like those. However, a recent study shows that many retirees offered this choice turned it down. For them, the emotional impact of a potential $10 loss is too great. While behavioural finance research shows that most of us weigh losses more heavily than gains, some retirees take this to the next level – they become “hyper loss-averse”.

The general investment principle is that as you age you have less time to recover losses. As a consequence, older people should tend to make more conservative investment choices. You would expect that retirees feeling more sensitive to losses aligns nicely to the investment principle of helping retirees make the right choices. Unfortunately it’s not that simple.

Consider guaranteed income or annuity products. You’d think that a very risk-averse retiree would be more likely to purchase an annuity. After all, an annuity eliminates investment market risk. Importantly, because some continue to pay an income as long as you live, they can also eliminate longevity risk, which is the risk of outliving your retirement savings. But hyper-risk-averse retirees are actually less likely to choose an annuity than are other retirees.

Why? Instead of being seen as a hedge against longevity risk, it’s often seen as a form of gambling – a gamble on whether you die early and lose the capital you used to purchase the annuity. This is one of the major psychological effects that have been blamed for the relatively low uptake of guaranteed income products, despite the benefits they can provide many retirees.

With an ageing population and a tightening budget limiting the government’s ability to underwrite retirement incomes, it’s a significant issue for many retirees and for the country. As such, it was raised by David Murray’s Financial System Inquiry report late last year. “Greater use of risk pooling could significantly increase retirement incomes generated from accumulated balances,” the report stated. It went on to recommend “using behavioural biases to encourage rather than discourage the use of products that provide longevity risk protection”.


If behavioural biases are a major cause of the problem, how can they possibly help? Firstly, changing the way the decision is framed can make a difference. This can happen in a number of ways. One of them is whether you think of the annuity like an investment product (with a fixed return), or like an income. One study recently showed that 70 per cent of people chose an annuity product when it was presented in terms of an income, but only 21 per cent did so when it was framed as an investment.

Another behavioural bias that can help is our willingness to accept default options. The obvious example is our attraction to default super. The same principle can be applied to guaranteed income products. Establishing them as the default option for members for whom they are likely to provide the best retirement solution, potentially in combination with other complementary products, is likely to lead to greater take-up.

This was one of Murray’s recommendations. He stated that the “government should require superannuation fund trustees to pre-select an option for members to receive their superannuation benefits in retirement”. By establishing appropriate default options, this approach can also help mitigate the risk posed by our reduced capability to make complex financial decisions as we age.

Of course, guaranteed income products won’t suit everyone. There are a number of completely rational reasons why some retirees would decline to choose them. But there is sound basis to believe that more people should have them than do so today, at least as part of their retirement solution.

Behavioural biases got us where we are, but perhaps they can also bias us towards success in the future? Maybe. The problem is that overcoming biases by yourself can be difficult. For these suggestions to be effective they will need to be incorporated into super funds’, institutions’ and financial advisers’ approaches to retiree members and clients. There are early signs that some of them are taking this path.

Simon Russell is a director of Behavioural Finance Australia.