MONEY

Keeping Calm When the Market Goes South

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iStock

A financial adviser shares tips for easing anxiety in a rollercoaster market.

“It’s been too good for too long,” my client said.

She had every right to feel suspicious. With the markets appearing to be at an all-time high, she was justified in having that waiting-for-the-other-shoe-to-drop instinct. I understood her desire to tread cautiously.

The majority of baby boomers are at a crossroad in their lives: They want to retire, they should retire, and it’s time to retire. But they are extremely nervous nowadays about the markets’ record-breaking levels.

Over my many years of experience working with clients in this situation — they’re ready to retire, but they can’t quite pull the trigger — I’ve seen how scary it can be to make that potentially irrevocable decision. What if markets go down? Should they have waited? What if this, what if that?

It is human nature to question ourselves at times like these, but then again, times are always a bit uncertain.

I have found that the most important step in keeping clients calm in a volatile market is to have an investment education meeting regarding their risk level and market volatility at the start of our working relationship and routinely thereafter. Our clients are actively involved in assessing their own risk tolerance and choosing a portfolio objective that suits their long-term goals.

We also want to set the right expectation of our management so our clients know that we never sell out of the market just because things are starting to go bad. Market timing has not proven to be a successful growth strategy, which is why we work with our clients upfront to establish a portfolio and game plan they can live with.

Unfortunately, the inevitable will happen: The markets will go south, and clients will panic. How can financial planners ease clients’ anxiety? Here are a few suggestions:

  • Discuss defensive tactics. Show clients the dollar amounts they have in bonds and other fixed income. Translate that into the number of years’ worth of personal spending that is not in the stock market. Have an honest conversation about if that number will be enough over the long-term.
  • Leave emotion out of it. Talk to them about the danger of selling at the wrong time and illustrate how emotional decisions tend to do more harm than good. Remind them of how quickly markets can turn around after a big drop. It’s been known to happen on more than one occasion, so share your knowledge of these experiences. Let them know that you don’t want them to miss the upside.
  • Look at the positives. Reinvesting dividends and capital gains? Are clients making monthly contributions to a 401(k) or other investment accounts? Remind your clients that when markets are down they are buying at lower prices, which can work well for their strategy over the longer term. A down market also often makes investing easier and less frightening to buy, so that might be the time to purchase any equities they once worried were too expensive.

The markets will always have some level of volatility. As an adviser providing regular guidance and support, you want to do everything you can to help clients not overreact to the daily news, hard as it might be. Urge them to continue to think long-term. It may not always be easy to see, but today’s bad news may just be a client’s big buy opportunity, and they won’t want to miss that!

———-

Marilyn Plum, CFP, is director of portfolio management and co-owner of Ballou Plum Wealth Advisors, a registered investment adviser in Lafayette, Calif. She is also a registered representative with LPL Financial. With over 30 years of experience in the financial advisory business, Plum is well-known for financial planning expertise and client education on wealth preservation, retirement, and portfolio management.

MONEY Saving & Budgeting

4 Ways to Hit Your Money Goals

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Gregory Reid

It's one thing to know that you need to save more money, find a better job, or pay down debt. It's another thing to actually do it. Employ these strategies to stay on track.

Welcome to Day 2 of MONEY’s 10-day Financial Fitness program. Yesterday, you did a self-assessment to see what kind of financial shape you’re in. Today, we help you find the motivation to take your finances to the next level.

Okay, you’ve checked your vitals, and you’re probably feeling pretty good about your starting point. According to Gallup’s annual Personal Financial Situation survey, 56% of people in households earning $75,000 or more say they are better off financially now than they were a year ago, up from 44% who felt that way in January 2014.

But just as even the most devoted gym-goer can get complacent, your financial confidence could stop you from reaching the next level. “In good economic times people save less and spend more,” says Dan Geller, a behavioral finance expert and the author of Money Anxiety. Keep the eye of the tiger even when you’re doing great. Here’s how.

1. Make a Specific Goal

When you show up at the gym without a plan, there’s a good chance you’ll shuffle on the treadmill for a half-hour and call it a day. Your financial life is no different. To boost your performance, start by zeroing in on a goal. A study by Gail Matthews, a psychology professor at Dominican University, found that you’re 42% more likely to achieve your aims just by writing them down. Indeed, people with a written financial plan save more than twice as much as those without a plan, says a Wells Fargo survey. The more specific the goal, the easier it is to tackle. Rather than plan to “cut costs,” focus on, say, paying off your mortgage five years early.

2. Buddy Up

Much as a workout partner provides motivation to get to the gym, recruiting a family member or friend to hold you accountable is a good way to stay on track. In another study by Matthews, some participants shared their goals with a friend via weekly updates—achieving their aims 33% more often than those who did not.

3. Get a Nudge

Sometimes you just need a reminder. A study by the Center for Retirement Research found that bank account holders who got reminders about their savings goals put away more cash than people who didn’t. It’s easy to set recurring calendar reminders on your PC or phone, or try a service like FollowUpThen.com, which lets you schedule emails to your future self.

4. Stickk It

Need something with more teeth? The website Stickk.com allows you to pledge a sum of money toward a goal, sign a commitment contract, and pick a friend to monitor your progress. Achieve your aim, and you get the money back. Miss it, and you lose the money, which is donated to charity or a friend.

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MONEY Social Security

Why We Make Irrational Decisions About Social Security Benefits

piggy bank and hourglass
iStock

Everyone tends to over-weigh a sure gain compared with a slightly riskier gain, even if the expected value of the certain gain is lower.

Financial professionals often recommend that you wait until full retirement or even later before applying for social security benefits. An individual who’d receive $1,000 per month at full retirement age would get a mere $750 by claiming early at age 62. And that same person could get as much as $1,320 per month by waiting until age 70. For many Americans, it appears to make a lot of sense to wait.

As a general rule of thumb, if you expect to live beyond your late 70s, waiting until at least full retirement might be the smart choice. According to the Social Security Administration, a man reaching 65 today can expect to live until 84.3. And a woman turning 65 can expect to live until age 86.6. Given that one out of every four 65-year olds today lives past age 90, you’d assume that most folks would hang on until full retirement before applying for benefits.

That assumption would be wrong, however. In practice, many Americans seem to be ignoring the data. According to The New York Times, 41% of men and 46% of women choose to take their benefits at 62 — the earliest age possible. Why aren’t they listening to the experts?

Your Social Security and your brain

Obviously, there are some very rational reasons for claiming your benefits at 62. For example, you might have some serious health concerns. Or you may just really need the money. Sometimes real life is more complicated than insurance data and actuarial tables.

There might be another powerful reason that people aren’t even aware of, however. According to psychological research, we are all hardwired to lock in certain gains, even if such a decision has a lower expected value. In other words, our psychology could be leading us to make suboptimal financial choices when it comes to social security.

The price of certainty

The underlying principle involved here, which was highlighted in the work of Daniel Kahneman and Amos Tversky, is called the “certainty effect.” This idea is actually quite easy to understand. Essentially, everyone tends to over-weigh a sure gain compared with a slightly riskier gain, even if the expected value of the certain gain is lower.

Here’s an illustration of how it works. Suppose there are two options. Option 1 gives you a chance to win $9,500 with 100% certainty. Option 2, on the other hand, provides you with the opportunity to win $10,000 with 97% certainty, though there’s a 3% chance you will win nothing.

Even though the expected value of Option 2 is higher ($9,700 compared to $9,500), the “certainty effect” would predict that more individuals would choose Option 1 than Option 2. According to Kahneman:

People are averse to risk when they consider prospects with a substantial chance to achieve a large gain. They are willing to accept less than the expected value of a gamble to lock in a sure gain.

A team of academics recently tested this theory, and reported their findings in a paper titled “Risk preferences and aging: The ‘Certainty Effect’ in older adults’ decision making“. They discovered that “older adults were more likely than younger adults to select the sure-thing option when it was available — even if it had a lower expect value.” In other words, they not only found evidence supporting the “certainty effect,” they found that older adults were moresusceptible to it than younger ones. The overall conclusion of the study is very instructive:

… [W]hen it comes to the important decision whether to claim social security benefits at the earliest retirement age (i.e., 62 years old) and receive a sure but lower-dollar payout (i.e., up to 20% less) versus a higher-dollar payout a few years later at full (between 65–67 years old) or after full retirement age (at 70 years age at the latest, with a benefit increase between 4% and 8% for each year after full retirement age until age 70) at the risk of not being alive, older adults might sub-optimally go for the sure payout at the earliest possible age rather than delaying their retirement benefits; thus, permanently reducing their benefits.

Clearly, our instincts can inadvertently lead us astray on financial matters. As Jason Zweig notes in his classic book Your Money and Your Brain, “[I]nvestors habitually are their own worst enemies, even when they know better.” When deciding when to apply for social security benefits, it might be wise to remember how our brains are wired. Otherwise, you could be leaving a lot of money on the table.

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MONEY consumer psychology

7 Ways to Trick Yourself into Saving More Money in 2015

piggy bank in various clamps and a vice
Steve Greer—Getty Images

These simple strategies can help you squeeze more out of your budget—and end the year with a lot more cash socked away than you started with.

If your New Year’s resolutions included growing—or starting—your savings, you’re already ahead of the pack.

Only about a third of Americans recently surveyed by Fidelity made any kind of financial resolution this year; and of those who did, just over half were aiming to stash more cash.

Kudos to you for taking this important step toward financial security.

Want to make sure your good intentions aren’t derailed before the month is out? The key is taking initial actions that will make repeating good habits easier, says University of Chicago economist Richard Thaler.

“We tend to revert to our long-run tendencies,” says Thaler. “To effect real changes, you have to make some structural change in the environment.”

With that wisdom in mind, the seven life changes that follow will help you save more money this year.

1. Use Inertia to Your Advantage

Research by Thaler and others has shown that people are victims of inertia: If you aren’t used to saving money with regularity, it’s likely going to feel like such a chore to start that you’ll never bother—or, you’ll quit after one account transfer.

But when your money is already being saved automatically, inertia works in your favor, since it’ll take more effort to stop saving than to do nothing. That is why a growing number of 401(k) plans offer automatic enrollment with a default monthly contribution rate.

Still, you may need to stick a hand in the machine if you want to have financial freedom in retirement, since the default rate (often around 3% of salary) won’t get you far in your golden years. Most planners recommend saving at least 10% of income.

Even if you set up your own plan, you probably haven’t touched your contribution rate since; more than a third of participants haven’t, according to a TIAA-CREF survey.

You can benefit from another relatively new feature called “auto-escalation.” Offered by nearly half of companies, auto-escalation lets you set your savings rate to bump up annually at a date of your choosing and to an amount of your choosing.

For other savings accounts, harness your own “good” inertia by setting up automatic transfers on payday from checking to savings (if you don’t see the money, you won’t get attached to it). Better yet, ask your HR department if you can split your direct deposit to multiple accounts.

2. Keep Your Eye on One Prize

Setting up automatic savings works well if your income and expenses are predictable; but what if either or both aren’t set in stone? You can save money as you go, but you’ll be more successful if you narrow your objectives.

Research from the University of Toronto found that savers often feel overwhelmed by the number of goals they need to put away money for—a stress that can lead to failure. Thinking about multiple objectives forces people to consider tradeoffs, leaving them waffling over choices instead of taking action.

One solution? Prioritize your goals, then knock out one at a time. If you know you need to contribute $5,000 to your retirement funds this year, focus on completing that first. Once it’s done, move on to saving for that dream home.

Another strategy is to think about your goals as interconnected; participants in the Toronto study were also able to overcome their uncertainty about saving when they integrated their objectives into an umbrella goal. So, for example, if you are saving for both a car and a vacation, consider setting up a “road trip” fund.

3. Focus on the Future

A part of what keeps people from saving is that we don’t connect our future aspirations with our present selves, research shows.

One way to get around that is by running some numbers on your retirement using a calculator like T. Rowe Price’s. When participants in a study by the National Bureau of Economic Research were sent exact figures showing how retirement savings contributions translated into income in retirement, they increased their annual contributions by more than $1,000 on average.

Another easy trick? Download an app like AgingBooth, which will show you how you’ll look as a geezer. One study showed that interacting with a virtual reality image of yourself in old age can make you better at saving.

This trick can work for more than just retirement. Another study found that when savers were sent visual reminders of their savings goals, they ended up with more cash stored up. Consider leaving photos of your goal (e.g., images of your children or dream home) next to the computer where you do your online banking to cue you to put more away.

4. Ignore Raises and Bonuses

As Harvard professor Sendhil Mullainathan has said, the biggest problem with getting a bonus is it’ll likely make you want to celebrate and spend it all—plus some.

The windfall creates an “abundance shock,” which gives you a misleading sense of freedom.

The simplest solution to this problem is to pretend you never got the raise or bonus in the first place, and to instead direct that new money into savings right away. (Remember the 401(k) auto-escalation tip? Set your contribution to bump up the week you get your raise.)

The same goes for when you return an item to a store for a refund or get a transportation reimbursement check in the mail. The faster you put extra cash into savings, the faster you’ll forget about spending it.

5. Make it Contractual

Carrots and sticks work.

One study asked smokers who were trying to quit to save money in an account for six months; at the end of the period, if a urine test showed them free of nicotine, the money was theirs. If not, the cash was donated to charity.

Surprise, surprise: People who participated in the savings account were more likely to have been cigarette-free at the six-month mark than a control group.

If you’re the type who responds to disincentives, enlist a buddy who can help you enforce upon yourself some kind of punishment if you don’t live up to your savings goal (e.g., you might promise a roommate that you’ll clean the bathroom for six weeks).

Maybe you respond better to positive feedback? Simply having a supportive friend or relative to report to on a set schedule may help you achieve results, as many of those who have participated in a group weight loss program like Weight Watchers can attest. Or you might look for some (non-monetary) way to reward yourself if successful.

You can use the website Stickk.com—inspired by the aforementioned study on smokers—to set up a commitment contract that involves incentives or disincentives.

6. Keep Impulses from Undoing Your Budget

Setting aside cash is only half of the equation when it comes to saving more: It’s just as important to keep spending under control.

Most people know to shop carefully—and early—for big-ticket items like cars or airline tickets (which are cheapest 49 days before you’re due to fly). But the premium for procrastinating on smaller items can also add up: Studies show that people spend more on last-minute purchases partly because shopping becomes a defensive act, focused on avoiding disappointment vs. getting the best value.

So give yourself plenty of time to research any item you’re planning to buy. And always go shopping with a list.

When you see an item that tempts you to diverge from your list, give yourself a 24-hour cooling-off period. Ask a sales clerk to keep the item on hold. Or, put it in your online shopping cart, until the same time tomorrow (chances are, that e-tailer will send you a coupon).

Or you could try this trick that MONEY writer Brad Tuttle uses to determine whether an item is worthy of his dough: Pick a type of purchase you love—in his case, burritos—and use that as a unit of measurement. For example, if you see a $120 shirt you like, you can ask yourself, “Is this really worth 10 burritos?” Likewise, you could measure the cost of an item in terms of how many hours of work you had to put in to earn the money to pay for it.

Also, since gift-shopping procrastination undoes a lot of people’s budgets, you might think about starting a spreadsheet where you can jot down ideas for presents year-round. That way, someone’s birthday rolls around, you can shop for a specific item on price rather than spending out of desperation.

Finally, remember that “anchor” prices can bias us to be thrifty or extravagant. So when you are shopping for products that range widely in price (like clothes or cars), start by inspecting cheaper items before viewing pricier ones. That way your brain will stay “anchored” to lower prices, and view the costlier options with more scrutiny.

7. Force Yourself to Feel Guilty

Surveys show that about a third of people don’t check their credit card statements every month.

That’s a problem, and not only because vigilance is your best defense against extraneous charges or credit card fraud. Seeing your purchases enumerated can also help reign in spending by making you feel guilty—one of many reasons people avoid looking.

Another perk of staying up-to-date with your bills: It makes you more aware of paying for redundant services, like Geico and AAA car insurance or Netflix and Amazon Prime and Hulu Plus.

Keep in mind that shaving off a recurring monthly payment gives you 12x the bump in savings. So a few of these expenses could boost your annual savings by a few hundred bucks. That’s a lot of burritos.

More on resolutions:

Read next: These Types of People End Up More Successful and Make More Money

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MONEY behavioral finance

A Financial Planner’s Most Important Job Isn’t What You Think It Is

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PeopleImages.com—Getty Images

Helping people who are panicking about money is more important than a particular plan or a piece of investing advice.

In the past few years, many of us in the financial planning profession have been coming to terms with a difficult truth: Our clients’ long-term financial success is based less on the structure of their portfolios than it is on their ability to adapt their behaviors to changing economic times.

An increasing number of financial planners are awakening to the fact that our primary business is not producing financial plans or giving investment advice, but rather caring for and transforming the financial and emotional well-being of our clients. And at the very foundation of financial and emotional well-being lies one’s behavior.

I’ve come to understand this over my own three decades as a financial planner, so I was pleased to see the topic of investor behavior featured at a national gathering of the National Association of Personal Financial Advisors in Salt Lake City last May. One of the speakers was Nick Murray, a personal financial adviser, columnist, and author.

“The dominant determinants of long-term, real-life, investment returns are not market behavior, but investment behavior,” Murray told us. “Put all your charts and graphs away and come out into the real world of behavior.”

This made me recall similar advice from a 2009 Financial Planning Association retreat, when Dr. Somnath Basu said, “Start shaking the dust off your psychology books from your college days. This is where [the financial planning profession] is going next.”

Most advisers will agree that, while meticulously constructed investment portfolios have a high probability of withstanding almost any economic storm, none of them can withstand the fatal blow of an owner who panics and sells out.

This is where financial advisers’ behavioral skills can often pay for themselves. Murray, who calls financial planners “behavior modifiers,” reminded us that we are “the antidote to panic.”

Murray said most advisers will try everything they can do to keep a client from turning a temporary decline into a permanent loss of capital. He wasn’t optimistic, however, that the natural tendency of investors to sell low and buy high will stop anytime soon.

His final advice was blunt. “Think of your clients who had beautifully designed and executed investment portfolios that would have carried them through three decades of retirement, who started calling you in 2008 wanting to junk it and go to cash. How many of these people have called you since then and tried to do it again?”

I myself could think of several.

“How many times have they gone out on the ledge and tried to jump, and how many times have you pulled them back in?” Murray asked.

By now I could see heads all over the room nodding.

Then he delivered a memorable line: “I am telling you as a friend, stop wasting your time on these people.” The heads stopped nodding. “Save your goodness and your talents for those who will accept help from you.”

I have certainly learned, often the hard way, that helping people who aren’t ready to change is futile. Yet I disagree to some extent with this part of Murray’s advice. If clients have gone out on the ledge more than once, but have called me and accepted my help in pulling them back in, then together we have succeeded in modifying their behavior.

This is a far different scenario from that of a panicked client who refuses help by ignoring a planner’s advice. If planners see our role as “antidotes to panic,” we need to realize that, for some clients, the antidote may have to be administered more than once.

———-

Rick Kahler, ChFC, is president of Kahler Financial Group, a fee-only financial planning firm. His work and research regarding the integration of financial planning and psychology has been featured or cited in scores of broadcast media, periodicals and books. He is a co-author of four books on financial planning and therapy. He is a faculty member at Golden Gate University and the president of the Financial Therapy Association.

TIME Education

How Sports Can Help Your Kids Outsmart Everyone Else

Houston Astros v New York Mets
Alex Goodlett—Getty Images Children yell to players after a game between the New York Mets and Houston Astros at Citi Field on September 28, 2014 in the Flushing neighborhood of the Queens borough of New York City.

Jon Wertheim is the executive editor at Sports Illustrated. Tobias Moskowitz is Fama Family Professor of Finance at the University of Chicago.

The playing field provides the ideal context for learning fractions, probability, equations, risk assessment, principles of finance, behavioral economics and even multi-variable calculus

Correction appended October 16, 2014

In her excellent book, Building A Better Teacher, the journalist Elizabeth Green tells a story of a new hamburger that the A&W Restaurant chain introduced to the masses. Weighing 1/3 of a pound, it was meant to compete with McDonald’s quarter-pounder and was priced comparably. But the “Third Pounder” failed miserably. Consultants were mystified until they realized many A&W customers believed that they were paying the same for less meat than they got at McDonald’s. Why? Because four is bigger than three, so wouldn’t ¼ be more than 1/3?

Green uses this example as one more piece of evidence that Americans suffer from a collective case of innumeracy, the math equivalent of not being able to read. But the A&W anecdote could also be used to underscore another national crisis: financial illiteracy. Even after a catastrophic recession—prompted, in part, by millions of us not grasping the terms of adjustable mortgages or the perils of an economic bubble—the subject of finance might as well have an “R” rating affixed. Come and see what all the fuss is about once you turn 18. It is the rare high school—much less middle school—curriculum that offers economics, and the rare K-12 curriculum that imparts simple lessons, such as the promise of compound interest or the peril of spending more income than you earn.

Put a dozen educational consultants in a room, ask them how to teach financial literacy, and you’ll get at least a dozen responses. There was once consensus that relevance and context are key. Show a sixth grader a supply and demand curve, it’s unlikely to be effective; instead, ask that same 11-year-old, “If the ice cream store has a line around the block, what would happen if they raised their prices?” But even that is up for debate. “The work often overwhelms the interest of the context,” says Dan Meyer, a former math teacher now studying math education at Stanford. “Calculating—putting numbers into a formula and then working out the arithmetic—is boring. Important, but boring. The interesting work is coming up with the formula.”

However, we would contend that there’s one context, popular among kids (increasingly of both genders), that is tailor-made for introducing basic concepts of economics and math, and a lot less boring: sports.

Just as a game is packed with fractions, probability, equations and even multi-variable calculus if you’re so inclined, so too is it a laboratory for risk assessment, principles of finance and behavioral economics—an emerging field that looks at the effects of psychology and emotion on economic decision-making.

In the aisles of Walmart or the listings for real estate, round numbers are powerful motivators, either to hit or to avoid. We’ll buy a 99¢ Coke, but are less inclined when it’s $1. We take pains to list homes for $99,999, not $100,000, when the difference is laughably negligible. And we do the same in sports. We hand a fat contract to a .300 hitter, but are less likely to do so to a batter that hits .299, never mind that the difference could be as little as two hits (or official scorer decisions) over the course of a season.

Sports also provide a context for probability. Broadcasters may ask questions hypothetically, but real answers exist. Jones is only a 40% free-throw shooter but he makes both. What are the odds of that?

If only one day a response would come: Well, I’ll tell you, Bob. Forty percent is 4/10. Multiply that twice for the two shots. 4/10 x 4/10 = 16/100 or 16%. Not good odds, but not extraordinarily rare, either.

And there are other examples. What is cutting a player from a roster if not taking a short position? A balanced line-up is a classic diversification strategy. Drafting a player at the same position as your star can be seen as a hedge against asset depreciation. That the baseball season started in Australia is a vivid example of international expansion and an attempt to alter consumer habits. Basic probability will explain why no one came close to winning the Billion Dollar Bracket Challenge that Warren Buffett sponsored during last March’s NCAA Tournament.

As Meyer notes, coming up with a formula might be more important than mere calculating. But, here again, sports can help. Sabermetrics in baseball and advanced stats in other sports are based on the premise of improving predictive models and deriving formulas. Half the fun of winning your fantasy league is the implication that you outsmarted (came up with a better formula than) everyone else.

If nothing else, any kid who’s been to both a hockey game and a basketball game knows the difference between thirds and quarters, and, in turn, would have picked the right burger.

Correction: The original version of this post misstated the title of Elizabeth Green’s book. It has been corrected.

Jon Wertheim is the executive editor at Sports Illustrated. Tobias Moskowitz is Fama Family Professor of Finance at the University of Chicago. Their 2011 book Scorecasting was a New York Times bestseller. Their new book, The Rookie Bookie, attempts to combine sports, statistics and financial literacy for kids.

TIME Ideas hosts the world's leading voices, providing commentary and expertise on the most compelling events in news, society, and culture. We welcome outside contributions. To submit a piece, email ideas@time.com.

MONEY retirement planning

3 Ways To Prevent Overconfidence from Derailing Your Retirement Plans

Proud Rooster
George Clerk—Getty Images

You need confidence to plan for the future, but unless you have a realistic view of your skills, you're likely to sabotage your own efforts.

Confidence can be a powerful force. RAND Corporation researchers have found that people who felt confident were more likely to plan for retirement than those who were more tentative. But confidence can cut both ways.

The rub is that confidence can too easily slip over the line to overconfidence. For example, EBRI’s 2014 Retirement Confidence Survey notes that Americans’ confidence in their ability to afford a comfortable retirement has been recovering from the lows of the financial crisis. Which is good, except the report then goes on to say that this rebound in confidence isn’t backed up by better planning for retirement: “Worker savings remain low, and only a minority appear to be taking basic steps to prepare for retirement.”

Psychologists and economists have long been fascinated by The Overconfidence Effect: the tendency for people to overestimate their judgment and abilities. Frenchmen think they’re better lovers than they are; university professors overrate themselves as teachers; investment analysts have an exaggerated view of their ability to forecast stock prices. Berkeley finance professor Terrance Odean has published numerous papers showing that overconfident individual investors sabotage their investment performance by trading too much.

So, how can you reap the advantages confidence can bestow without falling prey to overconfidence? Here are three tips:

1. Challenge yourself. The next time you’re about to make an investing or retirement-planning move—say, diversify into a new asset class or convert a big portion of a traditional IRA to a Roth IRA—ask yourself for a detailed rationale of why you believe this move is necessary, what evidence supports that view and what, exactly, you expect this move to achieve for you. Then come up with reasons this strategy might fall short of expectations and assess what the downside might be. And do it in writing, as this will force you to be more rigorous in your arguments. You might also go to one of the calculators in RDR’s Retirement Toolbox and plug in new investments or other strategies to see whether they enhance your retirement prospects.

If you go through this exercise and come away still convinced you’re doing the right thing, fine. Proceed with your plan. But if you raise issues that highlight potential weaknesses you hadn’t really thought through, you may want to hold off until you do more research, or just scale back your original plan (invest less than you’d originally intended in that ETF or convert a smaller amount to a Roth).

2. Keep a record. I don’t know about you, but I tend to remember clearly the times I was right about something and forget or gloss over the times I was wrong. That’s only natural. But to protect against this instinct—and give yourself valuable perspective on how often future events prove that your analysis (or gut instinct) was right or wrong—jot down your various predictions and date them. Believe that small-cap stocks are about to surge or inflation is poised to spike or the value of the dollar will fall? Write it down. That way you’ll be able to check back and see how good a financial seer you really are.

Here’s an exercise you can do right now. Think back to when the market was still on a roll before hitting the wall in 2008. Were you predicting stock prices were about to plummet? Did you act on that prediction? How about back in 2010 when everyone was absolutely convinced the bond market was in a bubble and prices were about to burst? Were you part of the bubble crowd? Bond prices did eventually drop and hand investors an annual loss. But that didn’t happen until three years later in 2013, and the loss was hardly devastating: about 2%. Meanwhile, people who fled bonds to hunker down in cash lost out on a gain of nearly 20% from 2010 through 2012, a three-year span during which money market funds and the like returned a total of less than 0.5%.

3. Put yourself on a short leash. It would be nice to think we act only after rationally thinking things through. But humans always have and always will also act impulsively and irrationally. So rather than trying (probably unsuccessfully) to completely stifle that impulse, you may be better off indulging it, but within strict limits. One way to do that: set aside a small amount of money in an “experimental” reserve account that you can invest or use however you please. The only stipulation is that this money remain separate from your regular savings and investments so you can easily see how well, or badly, your reasoned analyses, hunches, gut instincts, fliers (whatever you want to call them) turned out.

Who knows, if this account grows in value over the years, you may want to incorporate some of your “experiments” into your investing strategy. But if this account lags the growth of your regular portfolio or seems to be slowly seeping away, it may provide just the incentive you need to leaven your confidence with a little humility before you make your next financial decision.

Walter Updegrave is the editor of RealDealRetirement.com. He previously wrote the Ask the Expert column for MONEY and CNNMoney. You can reach him at walter@realdealretirement.com.

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MONEY behavioral finance

Save Money. That’s an Order

photo: joe pugliese Economist Meir Statman sees two populations: One that can be nudged into retirement saving, and another, more resistant group that needs saving to be mandatory.

Meir Statman, a finance professor at Santa Clara University, is one of the most influential experts in behavioral finance — the study of how your emotions and beliefs affect your decisions surrounding money.

Research in this field has led to a growing number of practices, such as automatic enrollment in 401(k) plans, intended to gently steer you toward smarter choices.

In presentations to financial advisers, and in his 2011 book What Investors Really Want, Statman explores how people try to balance the conflicting goals they have for their investments — for example, earning top returns while reducing risk.

Statman, 65, has now started to question some of the behavioral finance dogma that has been the focus of his work. In a new paper, he argues that improving Americans’ retirement security may require something stronger than a polite nudge.

His conversation with MONEY senior writer Kim Clark has been edited.

You’ve studied behavioral finance for more than 30 years, and you’ve seen many efforts to nudge people in the right directions. Do they work?

Nudging is very useful. Lots of people were nudged into saving for retirement by making it automatic and adding automatic escalation of savings.

Fifteen years ago, I might have said that would do the job. I doubt it now, because I see almost two populations: one that can be nudged into retirement savings, and another that is resistant. For them, we need to go beyond nudge into shove, and make retirement savings mandatory. I’m reluctant to shove people. But I think half of us, maybe more, are in a crisis.

So what’s your plan?

It’s similar to a 401(k) except that it is mandatory instead of voluntary. Employers would administer it. For self-employed people, there would be something like the insurance exchanges in the new health care law.

How much would people be required to save?

We should set a relatively low minimum, say 8% of one’s income, satisfying pressing retirement needs. Ideally the level would be closer to 15%. That’s the range in other countries that have created mandatory savings plans, such as Israel and Australia.

This is on top of Social Security?

Precisely. You might ask, “Why not just expand Social Security?” but that is not likely to fly politically, and enacting my proposal would require a new federal law.

Social Security is an insurance plan more than a retirement savings plan. It is fair for us to insure one another against dire poverty and disability. It is unfair, however, to ask us to assure others of a comfortable retirement.

Your plan seems very paternalistic.

People would resent it today, but be grateful later on. God knows, we all can tell stories about stuff our mothers forced us to do that we resented then, but for which we are grateful now.

When my dad was young and had young children, he wanted to take money from his pension fund to build another room to our house so there would be more room for the kids. He was turned down. In retirement, he was very grateful that he had been turned down, because it meant that he had more income and could live more comfortably.

We all face dilemmas between consumption now and later. A mandatory savings program prevents you from succumbing to temptation, even to one that is quite reasonable.

If I’m a person who saves already, why should I support your plan? Why should you be permitted to meddle in my life?

Savers should be indifferent to a requirement to save, because they do it anyway.

A resistance to mandates, of course, is part of American culture. I just hope that it can be overcome.

Think about spendthrift parents who arrive at retirement with nothing. And think about their adult kids who are savers. Those children might resent supporting their parents, but they are not likely to abandon them.

If you don’t make the nonsavers save, one way or another they are going to fall on the shoulders of the savers.

Let’s move on to other financial behavior. What are some big errors people make when investing?

One is applying wrong analogies from other parts of their lives. People think that experience will make them more competent investors, just as surgeons become more competent by performing more surgeries. Well, the analogy does not necessarily apply to investing, because the human body is not trying to fool the surgeon by moving the heart from one place to another.

In investing, the person on the other side of the trade will try to fool you. It might be an insider. It might be someone with special knowledge. People have to be disabused of the notion that investing is like surgery and realize that it’s more like a tennis game where your opponent may look weak but, in truth, is much better than you.

What else?

Hindsight. If you kept a diary in 2007, it would likely say something like, “I think that the market is high. I’ll wait a bit, and then decide.” It would be wishy-washy. But we all look back at 2007 and we say, “Wasn’t it clear that the market was going to go down?”

That kind of hindsight gives you the confidence that you can tell the future as well as you can the past.

Later on you might be tempted to sell your stocks because you are sure that their prices will fall — only to find, three years later, that stock prices doubled while your cash was in a money-market fund.

So whenever I feel like saying, “I just knew it,” I tap myself on the forehead and remind myself that I didn’t. We are intelligent beings. We can identify cognitive errors and set a defense against them.

You point out that people often overlook the emotional reasons behind their investing. Can you give me an example of that?

I hope that people who trade heavily can admit to themselves that they do it not just to make more money, but because it is fun. Trading, of course, loses people money on average, but it can be fun the same way that playing videogames is fun.

I say, “Well, you know, everything in moderation.” Just don’t overdo it.

What’s another way that emotions can affect investing?

When people are feeling poor, they are willing to take more risks.

You can have two people each earning $100,000 a year. One of them says, “This is plenty.” The other feels behind. That one is more willing to risk losses in the hopes of reaching his or her aspirations.

Are there ways in which our emotions and biases actually improve our investment returns?

Whenever you trade stocks, you expose yourself to the possibility of regret. You might find out later on that you would have been better off doing something else.

I think that the anticipation of regret prevents many people from doing something stupid, such as selling all their stocks in March of 2009.

So to the extent that our aversion to regret causes us to buy and hold rather than time the market — because any action opens a door to regret — that is a cognitive error that helps us.

Have you seen any evidence over time that people are getting smarter about investing?

You know, I thought that I would be blue in the face before people were going to believe the logic and empirical evidence that index funds do better, on average, than actively managed funds. But it seems that people are learning and getting smarter.

There has been an increase in the proportion of investors’ money that is going into index funds and exchange-traded funds. And I’m not blue in the face!

MONEY Saving & Budgeting

Stick to Your Money Goals…or Pay Up

This month, I’m highlighting a few extra tips that got cut out of a column in the January/February issue of MONEY on “Making Resolutions Stick.”

You’ve got some great financial plans for 2011, but if you’re feeling a little energy dip about now, don’t fret.

Money goals often fall prey to inaction, experts say, because they typically require time-consuming research or complex steps. (Think of what goes into choosing a 529 plan, or the lifestyle changes you have to make when paying back debt.)

To overcome that pesky inertia, says Yale professor Ian Ayres, author of Carrots and Sticks, you need external incentives to help you stay the course. And few things help people hold up their end of a bargain more than knowing they could lose a chunk of cash.

To that end, Ayres and two colleagues have created Stickk.com, a website that encourages you to set goals — and agree to pay a financial penalty if you fail.

The system is ingenious, and scary, because it forces you to put some teeth into those promises you make. Here’s how it works:

  • After signing up for a free Stickk.com account, you state your goal.
  • You set the time frame, when the goal starts, and how often you’ll report on your progress.
  • You agree to pay a monetary penalty if you fail, or if your referee (someone you designate to monitor your progress) finds you’ve dropped the ball.

Even worse — or better, depending on your perspective — you can direct your penalty to be paid to a charity, a friend, an enemy or a cause you despise (either the Brady Center to Prevent Gun Violence or the National Rifle Association, for example, depending on which side of the gun control/Second Amendment debate you favor).

In my case, I’m looking at the Stickk website now, trying to make myself enter my credit card information so that, if I fail to stay on track with the final push for my almost-there emergency fund, a $25-per-week penalty can be sent to a certain ex-president’s official library.

There’s only one flaw with this website: Who is going to make me stick to my decision to make myself Stickk to my New Year’s resolution?

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