The Illusion of Wealth

When you think of the money you have accumulated over the years, do you think of it as a lump sum or an income stream? This may seem like a trivial question, but it could have a major effect on how ready you feel for your future retirement.

On a recent vacation, I read a research study titled “The Illusion of Wealth and Its Reversal” by Daniel Goldstein, Hal Hershfield, and Shlomo Benartzi. The primary focus of the research was on how people feel about their retirement wealth when expressed as a lump sum (e.g. $200,000) or as a monthly income stream (e.g. $1,000 for life).

The research found that people should look at their retirement savings as a monthly income stream, instead of as a lump sum. The main reason for this, is because it is easier to draw a connection between your monthly income and your monthly expenses. After all, we want to be assured that we can pay our monthly bills when our salary is discontinued in retirement.

Studies that were conducted with participants showed that people with smaller retirement account balances (e.g. $25,000 - $100,000) overestimated the retirement income their savings would provide them. On the flip side, people with larger retirement account balances (e.g. $1,000,000) underestimated the retirement income their savings would provide them.

In the conclusion, the researchers provide the following guidance to retirement plan providers -

“To help people reason better about spending in retirement, retirement plan providers should provide people with their projected monthly income at retirement based on their current saving behavior instead of the current practice of providing only account balances.”

This goes along with a post I wrote in the past, The 4% Rule. Here we show how 4% of your investment portfolio should be able to provide you income for life. Instead of looking at the lump sum value of your accounts, ask yourself if the amount you have saved will pay all of your expenses in retirement.

Source: The Illusion of Wealth and Its Reversal

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