You may not know him, but the latest Nobel Prize winner knows a lot about your relationship with money. Professor Richard Thaler, author of the best-selling book Nudge, wasawarded the prizein October for his contributions to the field of behavioral economicsessentially, the study of how and why we make real-life financial decisions.
A lot of behavioral economists research centers around the fact that were pretty muchhard-wiredto goagainstsound economic reasoning and to make a big mess of our finances. But were not doomed to failure. We can use what theyve learned about how our brains workfor and against usto set ourselves up for success.
Here are four ways Nobel Prize winners say we can do just that.
1. Automate your way to wealthy.
Thestatus quo biasis our tendency to leave things as they are, which, depending on the circumstances,can work in our favor. Thanks in part to Thalers research, many companies now automatically enroll employees into a401(k) retirement plangiving you an option to optoutrather than in (with the knowledge that most people wont)and defaulting to a set contribution. Stick with the default (a natural instinct) and youll still end up on the right course. Even better, a majority of firms that automatically enroll participants alsodefault them into automatic escalation programsthat increase contributions annually.
Thebenefits of automationextend well beyondretirement savings: Setting up automatic transfers to savings and other investment accounts, as well as putting your bills on auto-pay, can also ensure you stay on track.
2. Ignore bad nudges.
Automatic enrollment in a 401(k) is a good nudge. But there arebad ones, too, which use our status quo bias against us. For example, you might one day see an offer for afree trialfor some subscription service if you supply your credit card number to get started. Sounds like a good deal, and youll definitely remember to cancelexcept you dont, and bam! Youre hit with a charge as soon as the trial ends.
That company was banking on inertia to keep you enrolled long enough to charge you. Knowing that, be wary of signing up for such good deals unless youre interested in using the service long term. Or create alerts to remind you to cancel in time.
3. Stop obsessively checking your investments.
Aslong-term investors, what happens to our investmentstodaydoesnt really matterso peeking at your portfolio all the time is unnecessary and potentially dangerous. In his book Thinking, Fast and Slow, psychologistDaniel Kahnemanwho won the 2002 Nobel Prize in economicswrites: Closely following daily [stock market] fluctuations is a losing proposition, because the pain of the frequent small losses exceeds the pleasure of the equally frequent small gains.
That loss aversionour tendency to feel more pain with losing than pleasure with winningmight prompt us to cut and run during a market down day. Better to limit our exposure (quarterly check-ins work just fine) and exercise our status quo bias in this instance.
4. Stick with your strategy.
Another common bias is calledherd mentality, which was on full display on October 19, 1987 (aka Black Monday), as investors charged out of the market and stocks fell by more than 20%the largest one-day drop in history. Economist Robert J. Shiller, whowon the Nobel Prize in 2013, surveyed investors afterward andconcludedthat the 1987 stock market fall was a panic caused by fear and based on rumors, not on real danger.
AFP/Getty Images Dr. Robert J. Shiller, 2013 Nobel Laureate for Economic Sciences.
Whats the best way to fight the urge to follow the crowd and panic sell? Equip yourself with a solid investment strategy, tailored to your goals, risk tolerance and timelineone that you can stick with no matter what. That way, you can confidently allow the status quo bias to take over regardless of whats going on with the market that day.
In fact, even on Black Monday, Shillers broker told him not to worry. The market began rising later that week, and in retrospect, stock charts show that buy-and-hold investors did splendidly if they stuck to their strategies,writesShiller.
Read the original article on Grow.