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Goals-Based Investing

Would you rather retire with $1 million or $5,000 a month?

By AMP Capital

Would you or your client rather a $1 million lump sum, or a $5,000 monthly income during retirement? It doesn’t really matter, though, does it? The $1 million and $5,000 a month, after all, are roughly the same (the $5000 a month is simply $1 million annuitized).

But the fact is we do tend to favour either a lump sum or income stream. But that bias, according to a recent research paper published in the Journal of Marketing, ‘The Illusion of Wealth and Its Reversal’, (outlined in a Wall Street Journal article), can create ‘illusions’ around wealth and poverty that lead to problems when it comes to personal financial decisions. The biases can mean clients save less than they need to, shun annuities, and even scrimp unnecessarily in retirement.

Advisers must understand these biases and the problems they create if they are to help clients not only shoot for the right retirement goals, but to also know which financial information and data they present to clients will best motivate them to reach those goals.

The experiment

The authors of the paper had a simple goal: they wanted to know if Americans would save more for retirement if they saw their retirement account expressed as income. Traditionally, just the lump sum amount was shown.

Yes $1 million and $5,000 per month are same. (As the authors note: a rule of thumb is that monthly annuity payments are about 1/200th of the corresponding lump sum, assuming they begin at 65.). But did people perceive money differently if they viewed it through different information lenses: either as the lump sum or the monthly payment?

It was an important question. That assumption underpinned new legislation, the Lifetime Income Disclosure Act, which was designed to coax Americans to boost retirement savings. It required financial services firms to display a new piece of information to Americans when they display their retirement accounts – the projected lifetime income that account can buy.

To find out, the researchers got two groups of adults to rank, based on a scale of 1 to 7 (one being totally inadequate; and 7 totally adequate), how adequate they thought an amount would be for retirement. One group saw money as a retirement lump sum (such as $1 million). The others saw it as monthly payments they could receive in retirement (such as $5,000 a month).

What they discovered has significant implications for financial advisers. Basically, people suffer from two important symptoms that can actually determine how much people save and spend.
Symptom 1: The illusion of wealth

Firstly, some people suffer from an ‘illusion of wealth’. They overvalued lump sums in retirement; they believed that $1 million was worth more than the $5,000 per month.
That’s understandable. There is something big, tangible and impressive about $1,000,000, particularly when it appears in your own retirement account. People “get a false sense of security from seemingly large monetary amounts.”

But that illusion carries a significant price: the risk of undersaving for retirement. People with a bias for lump sums may think they have more than they do, and therefore believe they don’t need to put away as much as they should to meet their lifestyle goals in retirement.

The illusion of wealth highlights another problem: clients’ reluctance to buy annuities. The researchers dub this the ‘Annuity puzzle’ – ‘the tendency for consumers not to annuitize their retirement wealth, even though many observers consider annuitisation a smart way to insure against outliving one’s savings.’

As they note, “if people perceive small lump sums as much larger than they are, exchanging them for what appear to be very small monthly payments would be unappealing, leading to under-annuitisation currently observed in the market.”

Symptom 2: The illusion of poverty
But others suffered from a second symptom, the ‘illusion of poverty’. They believed that $5,000 a month is more adequate than a $1 million lump sum.

People suffer from the illusion of poverty more as amounts of money rise. The authors say this is likely due to a ‘ceiling effect’: “A million dollars is a lot of money, but so is $2 million, and so is $4 million. In short, people become desensitised to large sums; all of those extra millions lose their meaning.”

Because we’re used to thinking in terms of monthly expenses, monthly income has a lot of importance to these people. But those suffering from the illusion of poverty also pay a price: scrimping and saving during retirement. “Instead of living the lifestyle they can afford, they worry they’re running out of money and act accordingly, skipping trips and scrimping on prescriptions.”

The implications for goal setting

As advisers know, psychology – the biases and preferences of clients – has an important role in the advice and investment process. As the paper found, even the lens through which clients view retirement – either as lump sums or monthly income – can distort behaviour and affect retirement outcomes. That has significant implications for the goals clients focus on, and what information advisers present to clients. More specifically:

• Advisers need to have greater awareness of the ‘illusion of wealth’ and the ‘illusion of poverty’ in clients’ thinking.
• To maximise retirement savings, advisers and their clients need to focus on not just a lump sum goal, but also projected monthly income. That will avoid the ‘illusion of wealth’ and undersaving symptom.
• When displaying information, advisers need to present their clients with both a lump sum and projected monthly income.
• Advisers need to have greater mindfulness of the ‘annuity puzzle’ – the reluctance to annuitize lump sums – including the role of the ‘Illusion of wealth’ and be able to communicate clearly to clients the benefits of annuitisation.
Advisers may know that at the end of the day the difference between a $1 million lump sum, and a $5,000 monthly income might be moot. But the answer for clients isn’t so simple, and the consequences of their answer are serious.


  • Goals-Based Investing
  • Retirement
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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.


This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

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