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How Behavioral Finance Paves the Road to Happiness in Retirement

How Behavioral Finance Paves the Road to Happiness in Retirement

Faculty Member Michael Finke Landscape Photo
August 1, 2019

A well-respected financial advisor once shared his advice to clients who dreamed of buying a motorhome and traveling across America as soon as they retired.

“I’d tell them ‘Sure! that’s a great idea,” he said. “But before you buy one, I know a company that’ll rent you a mid-size one for a month. Then when you come back you’ll know whether you’d rather have a big motorhome or a smaller one.”

Of course, this isn’t why he made the recommendation.

“Most of the time they’d come back and tell me ‘I’m never getting in a motorhome again in my life.’ I just saved them $250,000.”

As it turns out, most of us are not very good at predicting what is actually going to make us happy in retirement. We imagine spending money on the items we couldn’t afford earlier in life like a vacation home or an RV, but are these things really going to make us happy? What does make us happy?

Behavioral finance suggests that clients may not accurately predict how their spending will affect  happiness.

In my research, I’ve investigated whether spending on various categories of goods and services predicts life satisfaction in retirement. What doesn’t make us any happier in the long-run? Clothes, durable goods, cars, and gifts are all fun things to spend money on, but they don’t significantly increase life satisfaction. One category does: leisure spending.

And when we dig into the types of leisure spending that make us happier, what we find is that it is the social spending categories, such as eating out with friends or going on vacations, that really move the needle on life satisfaction. Spending money on things doesn’t make us any happier, but spending money to be with other people is what gives us satisfaction.

To many people outside of economics, this conclusion isn’t surprising. Like our closest primate ancestors, we’re programmed to enjoy activities that create greater cohesion within our social group. We’ve evolved to feel good when we’re with other people, especially other people we like. A recent study my co-authors and I completed on relationships and life satisfaction finds that quality time with friends is a particularly strong predictor of well-being in retirement. Even more than time spent with our own kids. Only time spent with a spouse among those with a solid marriage provided greater satisfaction.

In fact, the same part of a chimpanzee’s brain that is activated when one primate grooms another is the part of our own brain that activates when we laugh and tell stories with friends. The reason is that social species, like advanced primates, were much more successful because they could act cooperatively as a group to hunt and defend each other. And our brains are wired to maintain the social bonds that made our ancestors more successful as a species.

So why do some retirees love traveling in an RV while others hate it? The answer has far more to do with social interactions than it does with scenery or the joy of the open road. Those that love the RV life are the ones who enjoy spending time with others while on the road. Those that hated it likely never established bonds with others they met at RV parks. 

The same goes for vacation homes. After a recent presentation, a retiree shared the story of buying a dream home in a remote village on the ocean in Mexico. She lasted two months before packing her belongings and moving back home to be with her friends. Being on a beach sounds nice, but the scenery can’t make up for the social isolation.

Sound investment planning means recognizing client behavior and building strategies that use behavioral finance principles to create better results.

How can advisors help clients do a better job of planning for a life in retirement? First, recognize that we all have a basic need for social engagement. We’re likely to be happier if we live in the same place as our friends, or if we move to a living environment that is less likely to result in loneliness. 

Second, encourage clients to rent rather than buy a lifestyle before making a financial commitment.  Always wanted to live by a beach? Rent a vacation home for a couple of months and see how you like it.  Better yet, stay where you are and downsize your lifestyle to free up extra cash for spending time with friends and traveling. You’ll likely be a lot happier spending the $250,000 on cruises with friends than on a big apartment on wheels that takes you farther away from them.