Finding financial momentum

Too many choices and inexperience with complex issues are two of the biggest impediments to creating wealth. Limiting choices and automation, on the other hand, are great ways to improve your decision-making.

In their excellent book “Nudge,” authors Cass Sunstein and Richard Thaler identify a couple of reasons why most people are not very good at managing money. Through analyzing data, they concluded that people get better at stuff with experience and by receiving immediate feedback.

This is a big reason why most of us struggle with decisions regarding our retirement plans but find it pretty easy to find bargains when shopping online. We’re constantly shopping at places like Amazon, where we acquire vast experience and get instant feedback. It’s just the opposite with retirement planning. We don’t spend very much time on this task and receive virtually no guidance on our decisions. As a matter of fact, the feedback we do receive often comes decades after our choices are implemented. If we were wrong initially, the results could be devastating.

We’re also prone to inertia, with “do nothing” as our default setting when we’re confused or overwhelmed. We tend to become paralyzed when we have too many choices. So it’s not hard to see why we have so many problems planning for retirement.

Rather than try to overcome these tendencies, the best strategy may be to turn them to your advantage — like judo athletes using opponents’ own strength against them. Your default setting of doing nothing can become the foundation of a solid financial plan. As Warren Buffett likes to say, “Benign neglect, bordering on sloth, remains the hallmark of our investment process.”

With that in mind, here are five ways to automate your financial planning and improve your decision-making by eliminating unnecessary choices.

1. Sign up for your employer’s retirement plan as soon as you can. Contribute enough to at least receive the company match, and increase your contribution automatically each year. Try to increase your contributions by at least as much as your annual raise. If you change jobs, roll the money in your plan into an IRA or your new company’s retirement plan, and repeat the process. Invest in a low-cost target-date fund or a few inexpensive mutual funds and rebalance your investments every couple of years if necessary.

2. If married, get a low-cost term life insurance policy. Look for a policy with a death benefit of a couple million dollars and a term of 20 or 30 years and sign up. Have premiums taken out of your checking account automatically. You should receive a discount if you pay annually rather than in monthly installments. In addition, signing up at a young age enables you to pay much lower annual premiums.

3. When your first child is born, immediately open a 529 college savings account. Arrange to contribute $200 a month. Consider a direct low-cost plan from Vanguard to avoid the expense of a middleman. Choose a moderate age-based model, and move on with your life. Assuming a 7% annual return, this strategy over 18 years will bear great fruit — well over $80,000 to help pay for the cost of college. If you have another child, start a new account and fund it the same way.

4. Find a no-fee credit card that offers 1%-2% cash back. Allocate your reward dollars to a 529 or a personal investment account. Make sure you set up automatic payments from your checking account and pay the bill in full each month. If you put your monthly expenses on this card, a $1,000 bill each month could lead to the card company paying you $240 a year! And that’s not including any investment return or the miraculous effect of compounding over time.

5. Link the checking account where your paycheck is deposited to a credit union savings account or Treasury Direct. Set up automated transfers so that in a couple of years you will have accumulated three to six months’ wages for an emergency reserve fund. This will help you cover unexpected but inevitable expenses without having to borrow money.

While you may not be able to do all of these things, even just a couple would be a great start. The key is limiting your choices and automating. Let inertia work in your favor — instead of diminishing your chances for success, inertia will enhance it. Set up these programs and then do nothing. Take advantage of your natural inclination to accept the status quo. Properly funded and easily understandable automated systems will run on autopilot.

To again borrow the words of Warren Buffett, “There are no bonus points for complicated investments.” This goes double for anything else regarding your finances.

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