In this newsletter, we discuss human behaviour and how biases and pride may work very hard against achieving financial freedom in retirement. We look at loss aversion, lifestyle creep, and very importantly how to manage your salary increase. It’s those little changes in our behaviour, such as implementing a debit order auto-escalation for investment contributions, and an R5 jar for meaningful luxuries, that can make all the difference in the long-term.
Why be biased against some loss?
Loss aversion from an investment perspective refers to our tendency to prefer avoiding losses over acquiring gains. An example is the temptation to cash out of the market when equity hasn’t performed in the short-term. Investors tend to do this in fear of further loss and then lose out when the bull starts to run again (And when he does so, it’s unexpected and very fast, and you may lose out if you haven’t stayed the course.)
The concept of loss aversion also relates to savings. We avoid saving as we highly value, or realistically overvalue little luxuries, which could include dinner out on a Friday night instead of celebrating at home. This is similar to the concept of FOMO – Fear of Missing Out. It’s an irrational fear as it assumes there’ll be no similar and better experience or item to purchase in the short-term – instead of appreciating the great economic concept, which is that there’s always SUPPLY.
Lifestyle Creep
Loss aversion is related to lifestyle creep which occurs when people’s standard of living increases as more discretionary income becomes available to them. Their fundamental thinking patterns change, and they begin to regard luxuries as their right. Lifestyle creep is a self-generated inflation rate, which does none of us any good.
Examples of lifestyle creep include:
- Flying business instead of economy class,
- Replacing a car unnecessarily, and
- Purchasing a larger home despite children leaving.
Lifestyle creep doesn’t improve the true quality of life and can result in a financially stressful retirement.
The good thing is that keeping up with the Jones’s is fast going out of fashion. As much as we’re trying to save the planet by recycling plastic and eating less meat, we’re beginning to embrace minimalism, and the beauty of the concept of living simply. (Regarding saving the planet, it’s inspiring to know that in many international cities you can pay for public transport using plastic bottles.)
Your salary increase and the wonder of debit order auto-escalations
Now that you’re aware of the dangers of loss aversion and lifestyle creep, the big question is what are you going to do with your salary increase? First up, you’ll need to cover the increase in essential expenses such as medical aid and insurance premiums and school fees.
Once you’ve accounted for these increases that are unavoidable, next up is to increase contributions towards your retirement funds. This happens automatically if you’re contributing towards a company pension or provident fund, but you may have to implement the change yourself if contributing towards an RA. When you make the change, do automate the annual increase so that you don’t ever overlook it in the future.
Another very constructive way to use your salary increase is to start an emergency fund, which could be in the form of monthly contributions to a money market account. And remember, auto-escalation is your friend, and it’s best to set it at 20%. When the value of your emergency fund reaches an amount equal to six months of your salary, you can transfer the excess into a discretionary investment, such as the Kanan Wealth Retirement Wealth Builder.
And last but not least, there’s your health. Simply put, there’s no point in planning for retirement if you don’t look after yourself and won’t be around to enjoy your golden years. Life is stressful these days, and we’re all fragile regardless of our age. If you’re not on a top health plan, you may want to consider Gap Cover, which is relatively inexpensive. And get those running shoes going and have some fun.
Bottom line
At the end of the day, none of us is entirely rational, and it’s very helpful to understand your spending and investing behaviour. How about starting some behavioural change and ‘gifting yourselves a spring clean’ for your next birthday to start the process of de-cluttering your lives and living simply to free up funds to invest. Why not get an R 5 jar going to avoid waste and save up for luxuries that matter to you. And very importantly, get those debit auto-escalations going to avoid the peril of lifestyle creep.
Please contact Stuart Kantor or Jonathan Henning on 021 461 2429 if you’d like to discuss the content of this newsletter.
