All of us have pain, both physical and emotional, but we interpret this pain differently. In the financial realm, research tells us the pain of investment loss far outweighs the pleasure of gain. In many instances, some type of pain (not making progress towards goals, poor investment structure, etc.) is what brings people to us in the first place, so we have a keen interest in understanding the varying responses to pain.
Could pain, and how each of us perceive pain signals, provide clues to solving the huge intergenerational problem of under saving? Social scientist and economists alike have been studying this data for years and, overall the numbers paint a bleak picture. The Federal Reserve Bank of St. Louis publishes a very good chart (below) detailing the personal savings rate in the U.S.The chart measures the percentage of personal disposable income that Americans save on an annual basis. Including savings in retirement accounts, this percentage is under 6% at present. In the early 1980’s, savings were double the current rate and higher still in the early 1970’s. For most individuals, the rate of savings needs to be about triple the current average. A lot of pain is on the horizon unless substantial changes are made.
When we start earning money in our 20’s and 30’s, we assume that we are “bulletproof”. That is, because significant pain has often not yet been experienced, there is no expectation for pain to appear in the future. Of course, this mentality is pervasive not just in financial matters, but other areas of life as well. Once individuals make poor financial choices, (and suffer the consequences), pain becomes less abstract and this can cause them to seek help to avoid the reoccurrence of that particular pain.
Duke University Professor Dan Ariely is a leading researcher in behavioral economics and cognitive psychology. He suffered third-degree burns over 70% of his body from an accident as a teenager and therefore he is well acquainted with physical pain. This is an excellent video from a presentation he did a few years ago on adaptative responses and the differences in how we process pain signals. Professor Ariely explains how experience with pain helps immunize us to otherwise normal pain responses. This certainly holds true from our experience as long-term clients, (who have experienced numerous market swings), do not react to market volatility the same way as those with less personal experience.
The reason pain is so important for us to understand is that every choice and decision we make involves some type of tradeoff, some sort of pain. For example, if we decide to forgo that extra vacation so that we can save those dollars in our investment account, this creates some immediate “pain” in the loss of the extra vacation. In economics this is known as “opportunity cost”. That is, for everything we decide to do, we are not doing something else. In our current example, this pain is transformed into a positive by enhancing our financial capital.
The excellent point that Dr. Ariely makes in his presentation is that those who have become adapted to pain, (those with a higher pain threshold), understand that pain is a cost of “getting better”. That is, pain can be positive, not negative. Making that transition is the first step towards good financial decisions. Ready to change? Ready for a real conversation?