Easy Ways To Save For Retirement
March 10, 2012 by staff
Easy Ways To Save For Retirement, If F. Scott Fitzgerald were alive today he might say (though it doesn’t quite roll off the tongue) that behavioral finance experts are different from you and me.
How so? Well, they use their expertise to create tricks that help us non-rich folks make the right moves with our hard-earned money.
Consider, for instance, this gem: We all know that we should set aside three to six months of living expenses in an emergency fund. Most average Americans don’t do this. But those who do follow this age-old advice often tap those funds at some point for non-emergencies.
It’s just human nature, according to Michael Finke, an associate professor at Texas Tech University who studies behavioral finance, among other subjects. “Many recommend holding as much as six months of expenses in a cash account, but the temptation of such a large amount of money in a liquid account may too great for those who have difficulty resisting the urge to spend,” he said.
So, to get around this tendency to spend what we have, Finke suggests this trick of the behavior finance trade: Don’t put money earmarked for emergencies into a money market, savings or checking account, which are relatively easy to raid. Instead, put that money into a Roth IRA account.
The reason? You want to trick your brain into thinking that you are setting aside money for retirement rather than for emergencies. That’s because, according to the behavior finance experts, you’re less likely to raid an account labeled for retirement than your rainy-day fund. “This becomes particularly important when deciding where to save money for an emergency,” Finke said.
Of course, the money you contribute to a Roth IRA is just as accessible as money in a savings account. In fact, you can withdraw you contribution anytime from the Roth IRA without penalty. But odds are you won’t.
“Although tax sheltering is the primary advantage of a Roth, it can also provide a fence around the account that we aren’t tempted to access in the same way we might be tempted to spend money in a checking account,” said Finke. “This fence is what we call framing — where we see money as having different purposes depending on the account even though money is essentially fungible.”
To be fair, there are other ways to trick your brain. You could, for instance, put money earmarked for emergencies into some other instrument, such as a short-term bond fund within an investment account that has quarterly statements. “That helps reduce the need to resist temptation that comes from having ready cash in an account that is only a check away from being spent,” Finke said.
Of course, the larger goal of all this behavioral finance stuff is simply this. “By recognizing our limitations, we can arrange our financial accounts in a way that reduces the chance we will compromise our goals by succumbing to temptation,” said Finke. “This is why people cut up credit cards, withhold more taxes than they need to, and put their money in a piggy bank.”
So what then are some other tricks of the behavioral finance trade that consider our limitations and help us avoid the temptations that compromise our retirement and other goals? Well, to be fair some are well-known and well-used, such as auto-enrollment and auto-escalation. Others, however, not so much.
People will save more if you show them a photograph of their future selves, according to recent research.
“The problem between now and later is the question of how much do we care about our future selves,” said Dan Ariely, the author of several books including “The Upside of Irrationality,” and a behavior economics professor at Duke University. “If you care a lot you might save more, if you care only a little, you would save not so much. But if you saw an image of yourself at age 70 you might care more about your future self. And the results show that people have a higher tendency of doing so.”
So his advice to those saving for retirement is this: Take a picture of yourself, age it, and consider making it your screen saver on your computer or hanging the picture somewhere in your home or office to “to remind you of your future self.” By the way, there are several websites that allow you to see a picture of older self.
One such website is Face of the Future, from the University of St. Andrews.
Ariely had other tricks up his sleeve. For instance, he suggested creating two bank accounts, one for spending and one for saving. He also recommends that you purposely enter the wrong password into your online banking and brokerage accounts. “This makes it harder for you to get access to your money because you have to call the (the bank or brokerage firm) to retrieve or reset your password,” Ariely said.
Other tricks have to do with spending. “I think that there is a question of how we save smarter, but I think the real challenge is: ‘How do we spend less?’” said Ariely. “Saving is what we have after we finish spending, so if we can control spending we would be much better off.”
He recommends, for instance, looking at the sort of things we have set up for automatic payments. “The things that we pay explicitly for, every time we pay $3 for a cup of coffee, we notice,” Ariely said. “The things that are harder for us to notice are things that are automatically deducted from our checking accounts or from our credit cards. So I would take extra care to looking at those things and asking ourselves whether they actually bring us the amount of happiness that justifies their cost, things like cable TV for example.”
Ariely also suggests that you commit to showing a friend once a month your credit card statement and “justify everything you spent money on.”
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