Spontaneous financial decisions are not always in our best interest. In part 2 of our 3 part series, we will examine our tendency to heavily rely on the first information we receive and how too much pre-existing information can adversely affect our decision-making abilities.
In part 2 of our Retirement Blind Spot series (view part 1 here), we continue to examine our inclination to make spontaneous financial planning decisions that are not always in our best interest. The premise of why we often make bad decisions is rooted in the field of science known as Behavioral finance which combines behavioral and cognitive psychological theory with convential finance to explain why people make irrational financial decisions.
In our second article in the Retirement Blind Spot series, we look at anchoring bias, which is the tendency for us to rely on the first information we receive or too much pre-existing information when making decisions. Anchoring bias was discovered in the 1970s by behavioral psychologist Daniel Kahneman and his colleague Amos Tversky.
The Anchoring Bias Effect when Claiming Social Security Benefits
An example of anchoring bias related to financial planning is retirees' critical decision when claiming social security benefits. Granted, the rules and regulations that apply to Social Security can be confusing, and there is a dizzying amount of different claiming strategies. But according to the data, the number of retirees who claim benefits before full retirement age doesn't square with the number who should claim early.
The majority of retirees claim social security at age 62, years before their full retirement age. Since 62 is the youngest age to begin receiving benefits, it is often the first number people think of. And as we've learned, anchoring bias shows us the first piece of information we receive is often the most influential. In this case, age 62 becomes the anchor.
Often, retirees cite health issues or job eliminations as reasons for retiring early. And when forced out of the workplace, many people are looking for income from any source they can find. But Social Security isn't necessarily the best place to get it. Many investors could afford to delay even a couple of years if they tapped their Individual Retirement Account (IRA) before claiming Social Security. However, "57% claim Social Security before they take distributions from their Individual Retirement Account.1"
Point is, many people could delay taking Social Security which would provide a meaningfully higher level of income. In most instances (and even with the Social Security Administration's retirement age calculators) that someone is likely reducing their future benefit by claiming early.
What can you do?
Don't Let the Anchor Weigh You Down
Fortunately, there are a few steps you can take to protect yourself from the effects of anchoring bias:
- First, be aware of anchoring bias and acknowledge it. Then, next time you are making a financial decision, ask yourself if there is a piece of new or existing information that could be influencing you.
- Second, delay your decision. The brain is optimized for speed, which can lead to inaccurate or bad choices. Purposefully slowing things down can put you on the right track. Remember, there is a speed vs. accuracy tradeoff that creates a costly gap between “what I should do” and “what I actually do.” The result can lead to a blind spot in your planning process.
- Third, drop your anchor. Educate yourself. Knowing the powerful effect strategic anchors can have on your judgment can help you counter their impact.