Savings money jar full of coins concept for saving or investment for a house, retirement or education

People not saving enough for retirement has been a long-standing concern for both policy-makers and financial services firms. However, new research commissioned by the Massachusetts-based National Bureau of Economic Research (NBER) reveals that the reasons for this “undersaving” may have less to do with the financial choices people make over their lifetimes and more to do with underestimating the likelihood of events – such as unemployment, divorce and poor health – that undermine people’s ability to save.

Determining how much to save for retirement remains one of the most fundamental questions confronting investors, financial advisors and public policy- makers. Boston-based investments fund giant Fidelity Investments Inc. recently introduced a set of global retirement savings guidelines that aim to give investors a rough idea of what they should be targeting.

For Canadians’ objectives, the firm recommends workers aim for an ultimate savings target of 10 times their final salary upon retirement and save 16% of their annual salary each year. Fidelity’s guidelines also suggests that Canadians plan to draw down 4.5% of their savings each year during retirement to provide an income that represents about 45% of their final salary. This calculation assumes no workplace pension income and that retirees begin taking the Canada Pension Plan at age 65.

The recommendations for Canadians are in line with Fidelity’s guidance for U.S. workers, although the recommended annual savings rate in the U.S. is a touch lower, at 15%. For other countries, the guidance varies based on factors such as expected retirement age, projected life spans, forecasted investment returns and the likely contribution from public pension plans.

For example, Fidelity’s guidelines recommend workers in the U.K. save only seven times their final salary and draw down 5% a year, given the expected payout from government pensions.

In contrast, Fidelity’s guidelines recommend that investors in Hong Kong have a target of 12 times their annual salary in final savings, save 20% a year and plan to draw down just 4.1% of savings each year because of assumptions that workers there spend more time retired and face lower anticipated investment returns.

These new guidelines are intended to provide workers with a basic idea of how much they should save to meet their future needs. But a recent paper from the NBER, published in mid-November, approaches the question from the other point of view by examining the phenomenon of “savings regret.” That term refers to the belief among retirees that they should have saved more than they did during their working lives.

The NBER paper is based on a survey of people between 60 and 79 years of age, conducted jointly by the Munich Center for the Economics of Aging in Germany and California-based RAND Corp. The survey found relatively high levels of savings regret, with about 59% of retirees reporting they wish they had saved more.

These researchers acknowledged that it’s easy for retirees to say they wished they’d saved more in retrospect, when they don’t have to sacrifice actual consumption for greater savings. At the same time, the researchers sought to uncover the factors associated with this feeling of regret and found that reported levels of savings regret correlate with variables such as wealth and income levels – e.g., wealthier people report below-average levels of savings regret.

The researchers also aimed to determine the extent to which behavioural factors are associated with savings regret and found that even though characteristics such as a tendency to procrastinate contribute to savings regret, the effect is small: “[D]irect measures of procrastination have only modest explanatory power for regret.”

Instead, the research found that individual economic “shocks” – such as losing a job, going through a costly divorce or suffering from poor health – are much more closely associated with levels of savings regret. Namely, the research found that 66% of survey participants with savings regret said they suffered a negative economic shock early in their lives compared with 43% of those who don’t have savings regrets.

Although events that affect earning potential directly are likely to have an impact on savings, there are behavioural factors at play as well. The research points to traits such as overconfidence that contribute to the fact that people don’t account properly for the risk that they will face these events.

“[E]ven if individuals know in principle that risks are present,” the NBER paper states, “they may underestimate the probability that a negative event will happen to them personally, either because they have a superiority illusion or because they hold unrealistic beliefs about their level of control over external events.”

Yet, the risk that people will face these negative events at some point during their lives is high, the research notes. For example, the research found that baby boomers in the U.S. experienced an average of 5.6 periods of unemployment between the ages of 18 and 48; they had a 70% probability of experiencing at least three periods of unemployment; and the probability of divorce within 20 years of a first marriage was 48% for women and 44% for men.

“[A]nother mechanism to explain undersaving may be that individuals lack information to form beliefs about the likelihood of some or even most adverse events,” the NBER paper states. “In that case, working out an optimal saving plan is difficult, if not impossible.”

Ultimately, these results have important public policy implications, the research notes. The research suggests that because the underlying causes of insufficient retirement savings are related to investors underestimating the likelihood or impact of negative economic shocks on their ability to save rather than poor savings habits, governments’ and the financial services industry’s efforts to encourage greater saving should be designed with these results in mind.

For example, the NBER paper proposes that the causes of undersaving should be addressed by: policies that aim to educate investors about the probability and impacts of suffering negative events such as losing a job or going through an expensive divorce; and through programs that provide effective insurance against unemployment and workplace disability.