Annuity Puzzle #2: Is The Fear the Unknown Harming Your Future?
Explanations for why people don't buy annuities #2: Ambiguity Aversion
Sticking to what you know - whether it's your favourite pint at the pub or leaving your savings in the bank - may seem like a safe bet, but it might not be optimal. But, just like trying a new beer might introduce you to a new favourite, embracing ambiguity might make you make better retirement decisions.
According to this research, the same tendency to avoid uncertainty that makes you reach for your go-to drink can also impact your decision-making when it comes to your retirement savings. This tendency, called "ambiguity aversion", is an irrational tendency to prefer the known over the unknown and could be why people avoid buying annuities.
Ambiguity aversion can have negative impacts in everyday life. For instance, when deciding where to eat, people may choose a familiar restaurant over new and promising options due to uncertainty about the quality of the new options. Similarly, when planning a vacation, people may opt for a familiar location over a new and exotic one because of uncertainty about what to expect, potentially missing out on the holiday of a lifetime.
Ambiguity aversion can make us hesitate when there are too many unknowns about a product or service, even if it has great features. To counter this aversion, good marketing teams spend a lot of time and effort1 to make sure there's enough information available to potential customers, filling in any gaps in knowledge. For example, popular clothing companies want to make sure you feel good about their sizing options, manufacturing process, and return policies.
The reason for the existence of ambiguity aversion is our discomfort with uncertainty. Faced with the unknown, we tend to focus more on the potential drawbacks rather than the benefits, leading us to shy away from ambiguous options. It means that people are reluctant to make decisions about things that are uncertain, and nothing is more uncertain than our own mortality.
Embracing the ambiguity of your own mortality can pay off when it comes to securing your retirement. And let's face it, with technological change continuing at the pace it is, there is a good chance that that uncertainty is resolved to the upside and you last a lot longer than you thought possible. In that case, removing the uncertainty of you being able to provide for yourself might not seem so aversive.
Annuities are a good idea. Repeating a quote from an earlier post:
The intuition in favor of partial annuitization is simple. As far as outcomes are concerned, partial annuitization produces better “downside,” and a more aggressive conventional part of the portfolio produces a better “upside.” As a result, we have better outcomes across the board.
Modern Tontines are an even better idea as they cut out the insurance company.
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This is Modern Tontines and Target Date Fund Ladders, the start of a campaign to make Modern Tontines and Target Date Fund Ladders a reality. Modern Tontines don't exist yet despite them being a realistic solution [partial solution] to the looming retirement crisis. Target Date Fund funds exist, but not enough of them to make an effective ladder. They'll need a collective effort on all our parts to make them a reality.
Modern Tontines might sound complicated, but they're not really. In a future post, I'll make the logic & maths really simple. I like Target Date Fund Ladders as the vehicle for Modern Tontines because they're easy to understand too. Again subjects for future posts - but please get in touch and chat if you want to talk about it first.