Finding financial momentum
Too many choices and inexperience with complex issues are two of the biggest impediments to creating wealth. Limiting choices and automation, on the other hand, are great ways to improve your decision-making.
In their excellent聽book 鈥淣udge,鈥� authors Cass Sunstein聽and聽Richard Thaler identify a couple of reasons why聽most people are not very good at managing money. Through analyzing data, they concluded that people get better at stuff with experience and by聽receiving immediate feedback.
This is a big reason why most of us struggle with decisions regarding our retirement plans but find it pretty easy to find bargains when shopping online.聽We鈥檙e constantly shopping at places like Amazon, where we acquire vast experience and get instant feedback. It鈥檚 just the opposite with聽. We don鈥檛 spend very much time on this task and receive virtually no guidance on our decisions. As a matter of fact, the feedback we聽诲辞听receive often comes decades after our choices are implemented. If we were wrong initially, the results could be devastating.
We鈥檙e also prone to inertia, with 鈥渄o nothing鈥� as our default setting when we鈥檙e confused or overwhelmed. We tend to become paralyzed when we have too many choices. So it鈥檚 not hard to see why we have so many problems planning for retirement.
Rather than try to overcome these tendencies, the best strategy may be to turn them to your advantage 鈥� like judo athletes using opponents鈥� own strength against them. Your default setting of doing nothing can become the foundation of a solid financial plan.聽As Warren Buffett likes to say, 鈥淏enign neglect, bordering on sloth, remains the hallmark of our investment process.鈥�
With that in mind, here are five ways to automate your financial planning and improve your decision-making by eliminating unnecessary choices.
1. Sign up for your employer鈥檚 retirement plan as soon as you can.聽Contribute enough to at least receive the聽, and increase your contribution automatically聽each year. Try to increase your contributions by at least as much as your annual raise. If you change jobs, roll the money in your plan into an IRA or your new company鈥檚 retirement plan, and repeat the process. Invest in a low-cost target-date fund聽or a few inexpensive mutual funds and rebalance your investments every couple of years if necessary.
2. If married, get a low-cost聽听辫辞濒颈肠测.听Look for a policy with a death benefit of a couple million dollars and a term of 20 or 30 years and sign up. Have premiums taken out of your checking account automatically. You should receive a discount if you pay annually rather than in monthly installments. In addition,聽signing up聽at a young age enables you to pay much lower annual premiums.
3. When your first child is born, immediately open a 529 college savings account.聽Arrange to contribute $200 a month. Consider a direct low-cost plan from聽聽to avoid the聽expense of a middleman. Choose a moderate age-based model, and move on with your life. Assuming a 7% annual return, this strategy over 18 years will bear great fruit 鈥� well over $80,000 to help pay for the cost of college. If you have another child, start a new account and fund it the same way.
4. Find a no-fee credit card that offers 1%-2%聽.聽Allocate your reward dollars to a 529 or a personal investment account. Make sure you set up automatic payments from your checking account and pay the bill in full each month. If you put your monthly expenses on this card, a $1,000 bill each month could lead to the card company paying you $240 a year! And that鈥檚 not including any investment return or the miraculous effect of compounding over time.
5. Link the checking account where your paycheck is deposited to a credit union savings account or聽.聽Set up automated transfers so that in a couple of years you will have accumulated three to six months鈥� wages for an emergency reserve fund. This will help you cover unexpected but inevitable expenses without having to borrow money.
While you may not be able to do all of these things, even just a couple would be a great start. The key is limiting your choices and automating. Let inertia work in your favor 鈥斅爄nstead of diminishing your chances for success, inertia will enhance it. Set up聽these programs and then聽do nothing. Take advantage of your natural inclination to accept the status quo. Properly funded and easily understandable聽automated systems will run on autopilot.
To again borrow the words of Warren Buffett, 鈥淭here are no bonus points for complicated investments.鈥� This goes double for anything else regarding your finances.
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