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How to Break Bad Investment Habits

Psych yourself into making more rational money decisions

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Are you irrational about money? I know I am. I spent my working life saving for my retirement, but now that I'm retired, I can't switch gears and start spending what I've saved. I will drive across town to buy wine on sale and then spend more for a glass at a restaurant than I just spent on that bottle. I think the dollar in my savings account is worth a lot more than the dollar in my checking account, and I regard the dollar bill in my pocket as practically worthless. I'm weird, and that's normal.

In fact, the vast majority of Americans are quirky about their money, so much so that an entire school of study about it — behavioral economics — has sprung up in the past two decades, its practitioners winning three Nobel Prizes along the way. Behavioral economists document our financial foibles and then propose ways we can psych ourselves into sounder money management.

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Some of our quirks are harmless (keeping that dollar in my pocket out of my savings account costs me only a few pennies of interest a year). But some of our all-too-human behaviors can really hurt our bottom line.

Here are a few of the most common idiosyncrasies these economists have discovered and ways we can protect ourselves from ourselves.

Quirk: We get financial advice from amateurs

Ken Robertson is an Austin, Texas, retirement plan consultant who used to administer 401(k) plans for large companies. He noticed a particular behavior among employees in the plans: workers seeking money advice from colleagues they perceived as most skilled — even if the skill had nothing to do with money. At one Las Vegas hotel, the employees all respected the talents of the sushi chef and sought him out for retirement investment advice. At a large supermarket chain, butchers were typically deemed to be among the most skilled workers on-site, and employees often turned to them for retirement guidance.

Fix: Talk to experts

Robertson and his colleagues used that information to bolster retirement savings. They targeted the sushi chef and the butchers for lessons on how bigger contributions built savings, knowing that other employees would ask for their advice. It worked — retirement-savings contributions went up company-wide, though individual workers might have done better to get true expert assistance or learn to manage their accounts themselves.

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Quirk: We think we know more about finance than we do

When it's plausible that another person knows something about finances, we overestimate our ability to judge the quality of his or her advice. Harvard professor David Laibson, a behavioral-finance expert, laments that many people will buy high-fee mutual funds and insurance products from financial advisers without ever really understanding how much they are paying or what the impact will be on their savings. It's why near-retirees still pack those “free” retirement seminars at restaurants, even though the advice is often dubious.

Fix: Get informed

Get educated about your finances so you don't have to rely on any single “expert.” There's a wealth of good free info online. One place to start is research firm Morningstar's Investing Classroom. Several investment firms, including TD Ameritrade, Charles Schwab and Vanguard, offer educational materials and calculators that can help with investing. If you want professional help, shop for a financial adviser who is a certified financial planner or is a certified public accountant with a personal finance specialist designation. Use an adviser who discloses fees and has fiduciary responsibility to put your interests first. Have a 401(k) at work? The company that operates it for your employer may also provide retirement-planning advice.

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Quirk: Having too many credit cards with balances

When you have balances on multiple credit cards, mathematically there's just one correct way to minimize your total payments over a set period of time: Send all your extra money to the card with the highest interest rate until that card is paid off. Then focus on the one that has the next highest rate. Another school of thought, which focuses more on good psychology than pure math, is to pay off the smallest balance first, so you'll be energized by that quick achievement.

But most people do neither, reports Neale Mahoney, a University of Chicago economics professor. They dole out money to different cards in proportion to how big the card balances are, his research found. That's because humans are uncomfortable betting on one thing, Mahoney says. We've heard we're not supposed to put all our eggs in one basket, and it makes us nervous to do so, even in situations such as credit card payoffs, where it makes the most sense.

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We're irrational in other ways with credit cards, too. Mahoney is now studying the common practice of carrying high-interest debt on credit cards even when we have enough money in savings (often earning negligible interest) to pay it off.

Fix: Pay off high-interest cards first

Focus like a laser on your highest-interest card, and send all the money you possibly can there until you burn the balance. And don't consider your savings account off-limits. Let's say you have a $2,000 balance on a card charging 18 percent interest (about the national average). Paying it down at the rate of $50 a month will cost you $1,077 in interest over the years. You're better off pulling $2,000 from your savings to pay the balance, then putting that $50 a month back into your savings account. If you have an emergency before you've saved enough to cover it, you can borrow on your card to cover it.

You might also consider playing the balance-transfer game: Move the balances from your high-interest cards to a new card offering a low (maybe zero percent) introductory rate for a specified stretch of time (often a year). You'll probably pay a onetime fee of around 4 percent, but that will still buy you time to pay off the balance. Do this if you're comfortably convinced you'll be able to pay off the balance within the introductory period. And definitely don't convince yourself it's OK to run up a new balance on an old card. That would be self-defeating.

Quirk: We save money in round numbers

We love our round numbers. Workers tend to contribute to their 401(k) plans in multiples of five — usually 5 or 10 percent of their salary — even when the evidence shows a different number might be more sensible. For example, most companies will match a substantial part of your contribution up to 6 percent of your salary; why stop at 5 percent? But we do. Similarly, academic researchers working with Voya Financial showed that the higher the suggested percentage of deduction, the higher that workers set their contributions — until the suggestion hit 11 percent, which they ignored. They much preferred 10 percent, even if a higher level was both affordable and sensible.

Many workers planning their future Social Security strategy also peg round numbers, according to researchers with the Anderson School of Management at the University of California, Los Angeles. Associate professor Stephen Spiller and his colleagues found in one study that many workers, when asked at what age they intended to start taking Social Security, picked the age when that benefit, stated annually, would clear the nice round number of $20,000. Yet when that same benefit was expressed not as an annual figure but in terms of a monthly payment — in this case, an ungainly $1,692 — workers would often choose a different age for beginning withdrawals.

Fix: Optimize contributions for retirement

Play your own mind games to build your retirement savings. If you get a bonus or a raise, pretend it doesn't exist and just shovel that money into your 401(k) or other savings account. Go for the round number if you must, though aim high: If you've been trying to put away 6 percent of your salary, aim for 10 percent. A good way to defer gratification, Spiller notes, is to take time to visualize the money you'll have in retirement and the specific ways you'll enjoy spending it. The more detailed your imaginary retirement is, the better you'll be at saving for it.

Longtime journalist Linda Stern is the former Wall Street and personal finance editor at Thomson Reuters.

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