Your brain will make you poor

Our brains are a problem. We're wired to respond to the immediate threats and gratifications of a simpler and more dangerous world.

Our short-term bias inhibits our ability to deal with longer-term issues—challenges that won't become real for 30 to 50 years. Challenges like preparing for a financially secure retirement.

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Shlomo Benartzi, a professor at UCLA's Anderson School of Management and co-chair of its Behavioral Decision-Making Group, told me this: Brain imaging shows that we use the same parts of our brains to think about our future selves that we use to think about strangers. If we are so estranged from our future, how can we be taught to care?

If our brains are the problem, how can we trick our brains into better financial behavior? This is the province of behavioral economists. Traditional economists tell us what we should do—how much to save and how to invest. Behavior economists investigate how to get us to do it.

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Three of the foremost behavioral economists are Benartzi, Richard Thaler at the University of Chicago and Cass Sunstein at Harvard University. Their works, including the books "Nudge" and "Save More Tomorrow," are fascinating peeks into the inner workings of human financial behavior.

Surprise, surprise: We're not entirely rational about our money. Some people think that because money is quantitative, it's analytical. That's wrong. Money is intensely emotional. More couples divorce over money than divorce over love and sex.

Let's look at some of the mental biases that get in the way of intelligent financial behavior.

Short-term thinking. We spend a great deal of energy thinking about the near future, and very little energy on the distant future. Many of us will spend more time selecting a restaurant for dinner than selecting investments for our 401(k) plan. How can we change this shortsighted behavior?

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People need to engage in thinking about the distant future—to imagine what their lives will be like—in order to care about it today. For retirement planning, the typical approach is to present 30-year financial projections. But that's analytical, not emotional.

Behavioral studies have shown that a more effective technique is somewhat odd: Show them pictures of themselves, modified to look like how they will be when they're older.

Introduce them to their future selves. When people can imagine their future, they will more readily prepare for it.

Immediate gratification. It's not that we don't want to save—or exercise or eat healthy foods. It's just that in the decision-making moment, we seek immediate gratification. Pleasure now trumps pleasure later.

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In another study, students were asked to choose a banana or a chocolate as a snack after class. When they were asked a week before the class, three-quarters chose a banana. But when they were asked at the actual snack time, three-quarters chose chocolate. Somehow healthy decisions are harder when it requires the sacrifice of immediate gratification.

What's the solution? Ask the students to order their snack—to commit to their decision—a week ahead of time. That's the same insight Benartzi and Thaler used in "Save More Tomorrow." Don't ask people to save more today; ask them to agree today to save more tomorrow. It works.

Reluctance to change. Over and over, academic studies and real-world data point to the fact that we are reluctant to change things. Behavioral economists call this "status-quo bias."

It's easy to leave things the way they are and difficult to make a change. Change requires thinking, decision-making and action.

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Marketers understand this and make use of it. They look for ways to set the default to "yes." They know the power of moving from opt in to opt out—as in the power of a subscription where each new month of service is automatically delivered, rather than each new month requiring a new purchase.

In 401(k) plans, when employees must take action to participate, select investments or increase savings rates, the number of employees who take these actions is relatively low.

The hurdle to get someone to make a change, even a simple one, is high. So why not make good financial decisions the default option? Benartzi did exactly that in his program for maximizing 401(k) participation, and the results were stunning. At companies that have implemented his program, employee savings rates have doubled or tripled.

Loss aversion. Sure, we all hate to lose something we've worked hard to get. But most of us hate losing something much more than we love winning the same thing.

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In other words, if you have $10, the fear of losing $1 is about twice as motivating as the desire of gaining $1. Aside from addicted gamblers, fear dominates greed.

Why is this a bad thing for your financial security? Because in the realm of long-term investing, too little risk can mean too little return.

A study of hundreds of thousands of users of financial-management software revealed that the average family holds more than 20 percent of their investable assets in cash. By some definitions, that behavior is "conservative." But it is not prudent.

The risk of a financial loss today is not as great as the risk of insufficient savings in retirement. And because the return on cash is so low, it doesn't build compounding returns.

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What to do? We all say we want to save and invest for a secure retirement. But remarkably, few of us do it. Forty percent of American households have no retirement savings at all. Another 40 percent have savings of less than $100,000. The retirement savings deficit in this country is estimated to be more than $10 trillion.

So if our brains are the problem, let's outsmart them. Let's use the science of human behavior to overcome our natural human failings.

—By Bill Harris, special to CNBC.com. Harris is CEO of Personal Capital.