Considering the fact that I will have written this weekly column for 17 years as of October, it is entertaining (for me, anyway) to sift through a raft of old material to see how much has changed. An October 22nd, 1999 column on Behavioral Economics talked about the relatively new science of understanding how people make financial decisions. To a large extent, we are our own worst enemies, and recognizing this fact has prompted the financial services industry to offer a variety of tools to help combat what is called “the status quo bias.”
It’s always dangerous when the investor begins to think. For many of us, the less we have to think, the better --- especially when we might be inexperienced or uninterested in the basics of managing money. Out of the woodwork have come a wide variety of automated planning tools that manage money in retirement accounts and other savings vehicles. The value of these tools is not so much that they make good decisions, necessarily, but that they make decisions --- period. The problem for many people struggling to improve their financial results, or hoping to avoid some disaster, is that they’re hit with “analysis paralysis” and can’t make any decision at all.
The problem is no longer academic. The fact is that we have a lot more money than we had twenty years ago --- $17 trillion and climbing is housed in mutual funds and investments we have to choose ourselves in most cases. We are alone with our money.
Several behavioral fundamentals get in the way of effective, profitable decision-making. The most common one for all of us is procrastination. We’ll get around to bumping up our retirement contributions, or starting them at all, when we get a few other bills paid off. “Paying yourself first” is the mantra that describes the best approach to accumulating financial security. There are some amazing stories of people we night describe as disadvantaged but self-disciplined who amassed fortunes as a result of good savings and investment habits. Life is full of the unpretentious ‘Millionaires Next Door.”
Not saving enough soon enough is one of the biggest mistakes. Young people have a terrific advantage of being able to save before they have all the commitments and costs of raising families. One common 401(k) mistake is to contribute just enough to meet the maximum amount matched by an employer rather than going beyond that amount to try to reach a larger portion of the $18,000 annual dollar maximum.
Some employers have adopted the so-called automatic enrollment or “negative election” feature in their 401(k) plans which automatically enroll new employees at a rate of, say, 3 percent of their pay unless they specifically opt out or choose a different contribution amount. The inclination, statistically, is for those enrollees to just shrug and stay with the deduction. Contributing becomes the status quo in this case as opposed to a non-contributor having to pick up a heavy pen and sign an enrollment form.
Too many investment choices also get in the way of saving money. It’s like the famous study at Stanford where 125 choices of jam on the shelves of the supermarket resulted in no sales. When they reduced the choices to six flavors, jam was flying out of the store. In the retirement world, a variety of investment packages and robotic on-line planning tools effectively facilitate the investment selection challenge. Target date retirement funds, for example, only require that the investor pick a retirement date. The fund then does all the thinking with respect to a stock and bond mix.
Shortening the psychological distance removes one of the impediments to effective early investing when it will do the most good. For young people, retirement is too far over the horizon, but emphasizing the ability to borrow from their accounts provides an element of immediacy that can jump-start a savings mentality. Painting a picture of the smug satisfaction that can come from quickly accumulating a sizeable investment account in a surprisingly short time can generate interest. When eyes would otherwise glaze over at the thought of “retirement,” any aspects of saving offering immediate advantages are worth extolling. The most compelling, for those having lived through the recent “Great Recession,” is the value of having a nest egg to tap when between jobs.