Economist Benjamin Graham may have said it best: “The investor’s chief problem—and even his worst enemy—is likely to be himself.” The good news is that simply being aware of the fact that our human nature often impedes our progress can help us make smarter decisions moving forward. Whether it’s our desire for instant gratification or something else altogether that keeps us from saving for the future, by doing what we can to keep human nature from getting in the way, we may all be able to remove the biggest challenge to our own financial success: ourselves.
So how do we limit that voice in the back of our heads (what author and blogger Seth Godin calls our “Lizard Brain”) that can have such a destructive impact on our money habits? Start by following these three rules of thumb:
Keep emotions out of the picture. Yes, it’s more easily said than done, but emotions have a nasty way of wreaking havoc on our investment goals. The reason? We simply want to win. It’s one reason investors are much more willing to invest in today’s headline-grabbing winner (whose stock is probably already overvalued) than a more conservative stock that is slowly gaining over time. Those emotions can fuel the desire to chase investment returns (rather than follow a slow and steady path to growth), discount challenging opinions (even when those counter opinions are based on data), and try to beat the market (rather than simply capturing the upside of market growth while carefully managing risk). To help keep your emotions at bay, stay conscious of your own “Lizard Brain” and its impact on your decisions. Even better, get help from an advisor you know will have the gumption to challenge you when your emotions get in the way.
Know when to make a change. Losing is no fun, but that aversion to loss can be devastating if it means you’re holding on to investments for all the wrong reasons. Maybe you inherited your father’s portfolio, and selling his picks feels disloyal—even if those choices don’t make sense in today’s market. Or perhaps you invested in a great company and saw some fantastic returns, but you can’t stand the idea of selling now, even as the stock price continues to drop. (For more on how loss aversion can damage your financial wellbeing, check out this article from moneycontrol.com)
To get yourself to make necessary changes, try to accept your losses and move on. On the plus side, there may be tax implications to a loss, so “selling low” isn’t always a bad thing. And if selling Dad’s stock tugs at your heartstrings, consider holding on to a smaller portion of what he chose. The most important thing is to know when change is needed, and to act accordingly.
Make it easy. Let’s face it: we humans prefer the easiest route to success. Put a closed box of donuts next to an open box, and there’s no doubt about which dozen will disappear first! Plus, the box with the lid on may never get opened. The donuts inside are out of sight and out of mind, despite the fact that removing the lid is the tiniest of obstacles. But it’s not our fault really… it’s our human nature to be receptive to what’s convenient.
When it comes to saving for tomorrow, do whatever you can to make it easy. Pay yourself first by setting up automatic contributions to your 401(k) or IRA. Create forced limits on your credit card. Place your emergency fund in an online savings account to help curb spending by adding the friction of having to transfer money to your checking account, and automate a weekly contribution to your savings account based on your budget. And be sure to read our blog post on the power of personal commitment. Remember that tomorrow is not that far from today, and the easier you make it to save, the more prepared you’ll be for tomorrow.
Want to learn more about how our brains impact how we save?
Behavioral economist Keith Chen’s fantastic 12-minute Ted Talk, Could your language affect your ability to save money?, explores how even the language we speak gives us a significant handicap! His research shows how, unlike English, which draws a hard line between the present and the future, other “futureless” languages don’t. Because tomorrow feels much closer to today for “futureless” speakers, they feel a much greater urgency to save. The result? They are 30% more likely to save in any given year, and they retire with 25% more savings compared to those of us who speak languages that make retirement feel like a different lifetime.
It begs the question: If we could find a way to make retirement less distant, would we make better decisions about our money?
See what you think. And enjoy!
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