If You Don’t Save Enough, Perhaps You Have ‘Exponential Growth Bias’
Here’s how to tell whether you underestimate the benefits of long-term saving. And how to fix it.
Investors often think their savings grow linearly, and not exponentially, leading to the belief that it is relatively easy to make up for lost time.exponential-growth bias is the tendency to neglect the effects of compound interest, which is what happens when earned interest is reinvested. Research shows that this bias matters: Households with a stronger bias tend to save less and borrow more.
you may have exponential-growth bias and should be mindful of making two common mistakes when it comes to saving for retirement.
The mistakes
The first isn’t saving enough, as exponential-growth bias leads people to underestimate the benefits of long-term investing.
The second financial mistake influenced by exponential-growth bias is taking on too much debt, as the bias leads people to underestimate the long-term cost of debt.
The fixes
Taken together, these two tendencies—saving less and borrowing more—can severely undermine individuals’ financial security.
instead of just telling people their interest rate, we should tell them how much they could expect to have or owe in the future based on that rate.
exposing employees at a Fortune 100 company to their future retirement-account balance if they continued to contribute (and their savings continued to earn 8% annually) led to a 14-percentage-point increase in those who said they wanted to save more.Similar effects were found when college students were given a simple chart showing the growth of their money over time.
exposing people to their projected monthly income in retirement (rather than a lump sum) can make people even more likely to boost their savings rate, at least when the lump sum is modest.
The larger lesson is that the best way to convince people to save more is to help them understand the reality of compounding, which is the magic that happens to their money when they invest it and leave it alone.
