Delayed Gratification

I really miss Gary Larson and his wonderfully irreverent cartoons. One of my favorite showed a lifeboat full of dogs, their ship sinking in the background. The dog in charge was asking, “We have enough food for 14 days. Who is in favor of rationing it out, and who is in favor of eating it all now?”

Anyone who owns a dog knows how they voted, and I’m sure those who don’t ownb a dog will guess correctly. Dogs are NOT into delayed gratification. Neither, it appears, are humans.

It appears that the two sides of the brain - the emotional side and the rational side – are in conflict when many decisions. In dogs the rational brain never gets a chance, and when you think about people’s financial behavior, you’d begin to wonder about them too.

A recent report I saw said that Americans are currently saving only 1 percent of their incomes. This compares with a range of 2 or 3 percent a few years ago and an historical range of about 5 percent. In Asia , it’s over 15 percent.

Now, frankly, I do not know exactly how they calculate the percentage, but I do know that at this point, less than two-thirds of Americans have some kind of tax-deferred savings account, 401(k) or IRA. With Social Security benefits declining as we get well into this century, this is cause for alarm.

According to the Brookings Institution in an article reported in The New York Times, “Can Shortcuts Be a Force for Thrift?” April 12, 2005, about one-third of Americans are financially prepared for retirement, and another third are not at all. You could argue that there is hope for the other third that are in the middle, those who can join the first group if they adopt a more disciplined approach to executing a prudent retirement plan.

But here again we see evidence of innate human behavior. The emotional side which is more closely linked with the primitive limbic system is the side that responds to immediate gratification, like buying stuff now. The rational side of the brain developed later and this is the part that is used to make decisions about abstract trade-offs about what might happen in the future. That’s the part humans are so proud of, but you’d wonder about why when you see how people fail to use it. The statistics demonstrate that even well-intentioned people do not do the rational thing when it comes to saving for retirement.

The good news is that another human factor is at work here, inertia. When people decide on a plan, it appears to be hard for them to change it. So once you get them to sign up for a 401(k) to be funded by automatic deduction from paychecks, people don’t change. The result is that many more people participate than if you relied upon them to make an annual decision to fund an IRA, for example.

More importantly, a new idea in pension funding is gaining hold, automatic increases from year to year. At one company savings increased from 3.5 percent of income to 13.5 percent over a four year period of time. It would seem that inertia can beat the limbic system if you create conditions for it to do so. I think that this is a move in the right direction.

Where I live I know that there are many people who under-fund their cash retirement systems because they believe that the increased equity in their home will be something that they can rely upon in the future. While the huge build up in wealth from real estate equity that has occurred in the last few years is terrific, you can’t spend that equity, and it is not as secure as many people think. If it is to be dedicated to funding retirement, then you shouldn't treat it like a piggy bank to be raided to fund current expenses.

As the stock market debacle of the past few years demonstrated, having all your eggs in one basket can be dangerous. Months before it imploded most Enron employees thought that their retirement funds were secure. I do not see a bubble bursting in real estate values, but it would be wise to have a balance in your assets, as in building an amount in financial assets like stocks and bonds equal to your home’s equity.

For those who would like to read this interesting article in its entirety, please e-mail me at randyj AT loan-wolf.com and I’ll send you a copy.

Be careful out there!