En español | Some of our financial fate is beyond our control. Markets boom and bust; inflation comes and goes. But we do have the power to change our own behavior. And that's important, because with finances, as with everything else in life, the wrong behavior can end up landing us in a very dangerous spot.
To avoid ending up in a place you don't want to be, take note of these seven sins of personal finance. Ignore them only at your financial peril. Or keep them front and center in your calculations, and enjoy a fruitful financial life.
Are you worried about outliving your money? If so, that's a good thing. While optimism can be a positive trait for many facets of life, it can be dangerous when it comes to money. Research reveals that those who are optimistic about having enough money for retirement don't worry enough about it. Their blissful optimism about the future hinders the motivation necessary to defer spending and save. And the pessimists who are worried about living under a bridge? They are invariably the best savers, says Michael Finke, professor of personal financial planning at Texas Tech University.
Solution: Making saving automatic is the key to protecting yourself against undue optimism and to building a nest egg. Putting automatic payroll deposits into a 401(k) retirement plan at work is one option, of course. But you can also have money deducted from your checking account each pay period and invested in a mutual fund or bank savings account.
Spending money on the latest shiny thing can sure make us happy. But research indicates that such happiness is short-lived. Jonathan Clements, the author of Jonathan Clements Money Guide 2016, says that through a process known as hedonic adaptation, we quickly get used to the new luxury car, and the happiness factor fades fast.
Solution: There will always be someone who has nicer toys than you, so stay away from the hedonic treadmill. If you're considering buying something big, take a long time deciding. Clements says that the anticipation of buying is really the best part and brings with it the greatest amount of happiness related to the purchase.
See also: Items to rent instead of buy
The failure to do anything with your money can drain the value of your savings if you let it. Investors have nearly $900 billion in money market mutual funds and $8 trillion in savings accounts at banks. Cash is comforting, especially during periods when the stock market causes so much pain. Unfortunately, much of the cash languishing in accounts is paying virtually nothing — a mere 0.01 percent annually. If inflation averages 3.2 percent (the historic average), you will lose 47 percent of your spending power in 20 years.
Solution: Stop using abysmally low interest rates as an excuse for doing nothing. As of the time of this writing, savings accounts at online banks such as Synchrony Bank are yielding as much as 1.05 percent annually, and five-year CDs with 180-day early-withdrawal penalties are yielding 2.20 percent. Moreover, 10-year bank CDs purchased through a broker are yielding over 3 percent. True, those rates are still low, but they will compound over the years. Meanwhile, zero percent compounded over 10 years equals zero.
Though it might seem like the opposite of inertia, impulsiveness can be just as deadly to your finances. The temptation comes when others tell you how rich they're getting from buying that hot stock and you take the bait. Or perhaps someone contacts you with an opportunity to make a high return with virtually no risk. Or maybe the stock market plunges, and the impulse to sell is irresistible.
Solution: Stop and think! In his book Thinking, Fast and Slow, psychologist and Nobel laureate Daniel Kahneman writes that we have two systems of thinking: System 1 is fast, automatic, frequent, emotional and subconscious. System 2 is slow, effortful, infrequent, logical, calculating and conscious. Before taking action based on that impulsive System 1, think more slowly, with System 2. Make sure you are logically considering the pros and cons.
Don't you hate it when someone giving you advice — financial or not — doesn't disclose a conflict of interest? Yet, surprisingly, you may be more at risk when an adviser does disclose a conflict. Research led by George Loewenstein, a professor of economics and psychology at Carnegie Mellon University in Pittsburgh, found that once advisers have disclosed a conflict of interest, they feel "morally licensed" to abuse a conflict, by, say, selling you a product and taking the highest commission. At the same time, you are more likely to buy the product due to what Loewenstein calls insinuation anxiety. Because the adviser has been upfront about disclosing the conflict of interest, you don't want to appear distrustful, so it's harder to say no.
See also: Protect your savings
Solution: Trust any adviser enough to listen but not so much that you follow blindly. Ask questions. Make sure you fully understand the answers. Loewenstein says to never immediately act on the advice. Instead, discuss it with someone who is knowledgeable and doesn't have a stake in the decision. Do some research online. Remember: Better investments tend to be simple and transparent.
We'd all like to make a bit more money on our investments. But greedily going after a high-reward, high-risk investment, even after careful consideration and with your eyes fully open, can often turn into a disaster. So how do we get better returns without undue risk?
Solution: Look for investments for which the lower-risk option can provide a better return than the higher-risk choice. Even on bank CDs, the Federal Deposit Insurance Corp.–insured online banks and broker-sold bank CDs previously mentioned pay higher rates than most local banks but without any more risk. Any time, however, you are promised high returns with virtually no risk, run away. Strangers don't typically contact you to make you rich.
Is your investment portfolio as cluttered as your garage? Do you have investments spread over multiple banks and financial companies? It can easily happen as the years go by and we change jobs, leaving 401(k)s with former employers, or when we relocate to different areas, not bothering to close out accounts.
Solution: Bring some order to your financial life by consolidating accounts. Consider using a target-date fund. A target-date fund holds a mix of stocks and bonds based on your expected retirement date. The fund's managers adjust the mix to be more conservative as your retirement draws closer.
Finally, you could hire an adviser to bring order and discipline. But make sure the adviser sticks with an investment plan. Advisers are people, too, and have the same tendencies as consumers toward chasing hot investments and indulging in the other deadly financial sins.
Allan Roth is a financial planner based in Colorado Springs, Colo. He writes a weekly online personal finance column for AARP.org.
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