Whether you keep up with Nobel Prize winners or are a mathematics-junkie, you are probably aware that Professor Richard Thaler was just awarded the Nobel Prize in Economics. What does that mean for the world in terms of finance? For over 30 years, Thaler has greatly influenced and researched the way we view financial choices and strategies.
Working as a behavioral economist, Thaler has spent much of his time studying how we think and act when it comes to money, savings, and finance in general. He has found that for many of us, we act on emotion most of the time; for instance, investors who purchase shares at a high price and sell immediately when share prices falls or the market becomes turbulent (when in fact, it is the prime time to purchase more). Thaler’s opinion after conducting years of research is that we are constantly misguided in our financial actions because of rooted mental prejudices from our upbringing and experiences.
So how can we stay on the right track when it comes to our financial decisions, removing emotion, overconfidence, or bad habits from the picture? Thaler and many other behavioral economists have suggestions that can help. Here are 3 tips to begin with:
1. Make all of your savings endeavors automatic.
About ten years ago, Thaler and a colleague created the Save More Tomorrow program using behavioral economics strategies. The goal was to help people boost their savings by defaulting employees into a 401(k) with automatic, consistent contributions. Today, the program’s principles are being used to boost savings plans of any type. Thaler found that when someone doesn’t have to make a decision or say no to something, they are bound to take the quickest and easiest course when it comes to putting aside money for something.
If you are ready to begin saving for a long or short-term goal, consider setting up simple, automatic withdrawals either directly from your paycheck or a checking account (which will then be transferred into your retirement or savings account). Your banking institution or employer’s human resources department can help you set this up. With studies showing automatic withdrawals can significantly boost one’s savings, make this your first move after creating a savings plan for your goals. Not sure how to get started in creating a retirement or general savings plan? Speak with a financial advisor who can help you build one.
2. Don’t react to news headlines.
Want to almost guarantee a financial mistake? React immediately to news headlines about stocks and the overall market. It is common to get a little startled when hearing bad news about the stock market but feeling scared, worried or fearful about your investments is the worst time to make a major decision. Thaler recommends to never act on emotion – whether fear, excitement, or alarm. Stocks fluctuate from day to day, and studies consistently show that buying stocks and holding them long-term can foster solid growth.
3. Curb overconfidence.
Years of research by behavioral economists including Thaler highlight that people tend to be overconfident, believing they know more than others. In the majority of these cases, they are wrong. But this bias causes issues for our finances, like believing we have the power to positively predict the next Google or Amazon. This bias also causes us to cut and run, letting stock shares go when we should be holding on to them (and in many cases, buying more).
Yes, there may be a time when you pick a fund or stock that had a great return but don’t let this inflate your ego into thinking you are suddenly more knowledgeable then the best economists or money managers in the world.
(Credit: Business Insider)
There are many other tips when it comes to building a substantial savings fund. Learn more about saving for college, retirement, travel or another goal with the help of Matt Logan.
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