Over the last five years, I’ve spent a lot of time traveling the world to talk to people about money. At least one common theme comes up again and again: anxiety. People are worried about the future and want to know what they can do to prepare themselves for a stable financial life.
As we shift away from collective retirement solutions like government programs and company pensions, greater responsibility rests on each of us to create our own plan. After hundreds of these conversations, I’ve come up with a strategy. It could just be the secret to the financial life you have always wanted. But before I share it, there are a couple of disclaimers.
First, it’s boring. I’ve tried over the years to make financial planning more exciting, but I can’t seem to do it. Some people on TV try to increase the excitement by yelling things like “Buy!” or “Sell!” What does work, however, is relatively dull. I compare it to watching an oak tree grow. It’s short-term boring, but long-term exciting.
Second, it’s hard. We’re talking about saying no to things we really want right now in exchange for something we will absolutely need many years later. That’s not what most people do. Most people buy things now because, of course, they deserve it. Eat, drink and be merry because tomorrow you die, as the old saying goes. But here’s the thing: If you think saying no today is hard, try eating cat food for the last 10 years of your life.
So the first thing you will need to do is embrace boring and hard things. In fact, with this plan, you may even come to love the boring and hard. Assuming you’re still with me, let me reveal the Sketch Guy’s very unexciting, four-step plan to the financial life of your dreams:
Step 1: Pay attention to your spending.
Call it budgeting if you want, but I’m essentially talking about paying close attention as you spend money. This could be as simple as keeping an index card in your pocket to write every transaction on, or purposefully reviewing your monthly credit card statement. Whatever your method, just start noticing how you are spending money.
Step 2: Find wasted money.
The hard part of saving isn’t saving itself. The hard part is finding the money to save. Not long ago, I figured out a routine that helped. I printed out my credit card statements and went through each charge.
On one statement, a few lines down on the second page, I found a charge for Gogo Internet service. That’s the Internet service available while flying on many airlines. I recall the charge being $39 a month for unlimited access. (Now, it’s $59 a month.) After highlighting the charge, I leaned back in my chair, deep in thought.
How long had it been since I had last gone online at 35,000 feet? In a moment of Zen-like clarity, I realized I hadn’t even been on a flight that month. I did the math and discovered it had been 13 months since I had used this service. For 13 months, I had been paying for something I wasn’t using. I had wasted more than $500. It’s crazy that I let it go on for that long, but I’m glad I found it.
Step 3: Automate savings.
If anything about this plan qualifies as exciting, perhaps it’s this: By canceling my monthly GoGo charge, I found $39 a month to start saving. Because I was already spending that money, it wasn’t even going to hurt. All I had to do was log in (not at 35,000 feet) and set up an automatic investment for $39.
I could even round it up to $50. Don’t get hung up on finding the best investment. That reeks of excitement, and we’re not into that. Just start something boring like a Vanguard Standard & Poor’s 500 index fund, or send the $50 to your children’s 529 education account. The important part is automating the behavior: Have the money transferred regularly from your checking account into whatever boring savings or investment vehicle you decide. No stamps. No envelopes. No will power.
Step 4: Repeat.
At the risk of making this plan sound like fun, what if you decide to turn it into a game? Kind of like a treasure hunt.
Every month, pull out your credit card statements and carefully take notice of every charge, look for wasted money and add it your automated savings. See how often you can move that number up. See if you can start a streak and raise the amount each month, even if it’s only by $5 or $10. It may sound dull to save $39, then $50, then $65 or even $67 (those two dollars matter) — but over time, those dollars add up. How high can the number go?
Some friends of mine played this game. They paid attention to their spending. They found wasted money. They automated their savings, and they repeated their actions for longer than a decade.
When they started, they had a goal of turning these incremental savings into $1 million. I remember thinking that goal was crazy. They would need to do something exciting like find a hot initial public stock offering or invest in the best mutual fund ever to make that work.
Then one day, I got a call. “Carl,” they told me, “we did it! We just crossed the $1 million mark.” Yes, it took more than 10 years of consistently doing boring things, but they reached their goal. It turned out that it wasn’t as hard as they thought because they had a plan. They automated the good behavior. And one morning, they got to be really excited about having $1 million in savings.
This commentary originally appeared July 20 on NYTimes.com
Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any links contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
The most compelling findings regarding financial decision-making are found not in spreadsheets, but in science. A blend of psychology, biology and economics, much of the research on this topic has been around for years. Its application in mainstream personal finance, however, is barely evident. Perhaps a simple analogy will help you begin employing this wisdom in money and life: The Rider and the Elephant.
First, a little background.
Systems 1 and 2
Daniel Kahneman’s tour de force, Thinking, Fast and Slow, leveraged his decades of research with Amos Tversky into practical insight. Most notably, it introduced the broader world to “System 1” and “System 2,” two processors within our brains that send and receive information quite differently.
System 1 is “fast, intuitive, and emotional” while System 2 is “slower, more deliberative, and more logical.” The big punch line is that even though we’d prefer to make important financial decisions with the more rational System 2, System 1 is more often the proverbial decider.
Many other authors have built compelling insights on this scientific foundation. They offer alternative angles and analogies, but I believe the most comprehendible comes from Jonathan Haidt.
The Rider and the Elephant
The author of The Happiness Hypothesis and a professor at New York University’s Stern School of Business, Haidt describes the two systems in a helpfully visual way:
The mind is divided in many ways, but the division that really matters is between conscious/reasoned processes and automatic/implicit processes. These two parts are like a rider on the back of an elephant. The rider’s inability to control the elephant by force explains many puzzles about our mental life, particularly why we have such trouble with weakness of will. Learning how to train the elephant is the secret of self-improvement.”
Do you see the connection? System 1, in this case, is the Elephant. It’s instinctive, powerful and predictably emotional. System 2 is the Rider. It’s the rational thinker, capable of deconstructing complex problems but incapable of overpowering the Elephant.
How, then, do we, as Haidt suggests, train the Elephant?
Elephant Training
First, recognize that the Elephant—emotion—is not the problem. Indeed, it may be part of the solution. Too many in the realm of personal finance have labeled emotion as the enemy. They tell consumers that investing, in particular, is best practiced by ignoring or suppressing emotions. But this is shortsighted.
Let’s say an investor is coached that the market goes up and down, but ultimately, a willingness to stay invested in stocks will net the best long-term returns. Therefore, one’s portfolio would be optimally invested wholly (or mostly) in equities. Well, suppressing one’s emotions regarding the fear of deep market losses might help an investor stick with their financial plan in a mild correction, but in the early 2000s and again in 2008, many an Elephant reared up and sent the rider on a precipitous fall of his or her own.
No, optimal portfolio construction involves inviting the Elephant into the boardroom to have a say. Emotions should not be ignored, but rather acknowledged and accounted for in the creation of an ideal investment portfolio. Practically speaking, this means that many people with equity-heavy investements—at any age—should listen to the Elephant and seriously consider increasing their exposure to a portfolio’s stabilizing force: conservative fixed income. It’s also important to recognize at this point that most households have two Riders and two Elephants, each of which needs to be heard.
The Rider and Elephant work best as a team. While this is readily apparent in most areas of investing, it becomes especially clear in decisions involving the prospect of death or disability. Statistically speaking, when it comes to writing estate planning documents and planning for death or disability with insurance, the collective Elephant has simply run for the hills, ignoring this possibility altogether. But the Rider can coach the Elephant very effectively:
Rider: “We need to talk about our will.”
Elephant: “Death? Ooh, no. I’m not going there.”
Rider: “I understand. It’s not exactly fun to consider, but what scares me even more is what could happen if we don’t consider it at all.”
Elephant: “Yeah, I guess I hadn’t thought about it that way.”
Rider: “Like, wouldn’t we rather decide who would take over our role as parent if we were gone, rather than entrust that important decision to the state?”
Elephant: “Yep, let’s schedule that appointment.”
Every great team has to practice in order to work together effectively, so try imagining the implications of your neuro-duo in any number of circumstances, from budgeting, insurance and allocating your 401(k) plan to even more important stuff, such as career, marriage and child-rearing. Through persistent practice, it’s even possible to transfer the once-complex tasks undertaken by the Rider to newly instinctive responses by the Elephant.
And if you’re interested in further training, consider choosing anything from the following reading list:
Thinking, Fast and Slow – Daniel Kahneman
Nudge – Richard Thaler and Cass Sunstein
Misbehaving – Richard Thaler
Blink – Malcolm Gladwell
Drive – Daniel Pink
Start With Why – Simon Sinek
Switch – Chip and Dan Heath
The Power of Habit – Charles Duhigg
The Happiness Hypothesis – Jonathan Haidt
This commentary originally appeared July 24 on Forbes.com
Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any links contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
Q: What Is the Federal Reserve System?
A: The Federal Reserve is the central bank for the United States. It is composed of 12 regional Federal Reserve Banks located around the country as well as the Board of Governors, the independent government agency, in Washington D.C. A 12 member board is selected from these entities to create the Federal Open Market Committee (FOMC). The Federal Reserve controls the country’s monetary policy with the dual mandate of stable prices and full employment with the goal of sustainable economic growth. Monetary policy is concerned with the amount of money and credit in the economy. The Federal Reserve is also in charge of regulating banks and other economically important institutions to protect depositors and ensure the safety of the financial system.
Q: What Is the FOMC?
A: The Federal Open Market Committee consists of 12 members, the seven-member Board of Governors, the Federal Reserve Bank of New York president and four of the remaining Reserve Bank presidents, which serve one year terms on a rotating basis. The Federal Reserve uses three primary tools to conduct monetary policy: open market operations, reserve requirements and the discount rate. These tools are implemented with the intention of influencing the federal funds rate which is the overnight rate that banks pay to borrow reserves from another bank. The FOMC sets the federal funds target and will decrease the rate to make borrowing more attractive and increase the amount of money in the federal reserve system and vice versa. The FOMC will lower the rate to try and spur economic activity when the economy starts to stall, and raise it to slow the economy when it is growing at an unsustainable pace. Many people falsely believe that the federal funds rate impacts all parts of the yield curve, but in actuality, when the Federal Reserve increases (decreases) the target rate, it will only directly impact short-term lending rates. A study by the Federal Reserve Bank of New York found monetary policy contributes to the increase in interest rates but is not responsible for persistent high rates.
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Historical Correlations |
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Effective Fed Funds |
Generic 2-year Treasury |
Generic 30-year Treasury |
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Effective Fed Funds |
1.00 |
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Generic 2-year Treasury |
0.38 |
1.00 |
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Generic 30-year Treasury |
0.29 |
0.71 |
1.00 |
The graph above displays the historical correlations between the effective Fed Funds rate, 2 year, and 30 year treasury. Historically, the 2 year treasury has more closely tracked the changes in Fed Funds rates than the 30 year treasury.
Q: What Are Open Market Operations (OMOs)?
A: Open market operations (OMOs) consist of buying or selling government securities to increase or decrease the money supply in the banking system. This is the primary tool used to influence the Federal Funds Rate and is typically done with short-term repurchase agreements. The Federal Reserve Bank puts upward pressure on short-term interest rates by increasing or decreasing OMOs. The recent rounds of quantitative easing, the large scale purchase of U.S. government securities by the Federal Reserve, is an example of unconventional monetary policy. The Fed used quantitative easing to drive down interest rates to encourage more borrowing and therefore spur more economic growth.
Q: What Is the Reserve Requirement?
A: The reserve requirement is the least known and used tool in the Fed’s arsenal. The reserve requirement is the amount of funds banks must hold at the Federal Reserve against their deposit liabilities. By increasing reserve requirements, the Federal Reserve can decrease the money supply available and potentially increase interest rates, slowing the economy.
Q: What Is the Discount Rate?
A: The discount rate is the rate at which Federal Reserve District Banks directly lend to depository institutions through the lending facility known as the discount window. The discount window is known as the lender of last resort, these loans are typically short term and the obligor is often facing liquidity or funding issues. Banks are hesitant to use the discount window because of the negative connotation of securing a loan from the lender of last resort. In theory, The Federal Reserve Bank may decrease the discount rate to make borrowing more attractive in times of crisis.
Sources: Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York Quarterly Review: Winter 91-92
Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.