The following is a guest post from Jon Stein, Founder & CEO of Betterment.
The factual, ?figures? side of money, often has us confused. We can crunch the numbers and figure out the best way to build wealth, but it doesn?t make financial success a certainty. This is because there?s a profoundly psychological element to managing money, and human instincts are often irrational.
The fact is that Americans are struggling to manage their finances: in a recent Gallup poll, 66% of people ranked not having enough money for retirement as their top financial concern. At the same time, people aren't taking the necessary steps to save the amount needed for retirement: according to a survey conducted by the Employee Benefit Research Institute, 46% of American workers have less than $10,000 saved for retirement.
How did it come to this?
Let?s take a look at why, when it comes to money, humans don?t do what we should.
Windfall Gains
Take, for example, an unexpectedly large tax return. How does your brain make sense of this gain? Do you make the most of it and boost your investments? Or do you view it as "free" money to be enjoyed? Chances are it?s the latter?
Mental Accounting
According to Dan Ariely, Professor of Behavioral Economics and Author of ?Predictably Irrational?, we allocate money to different categories and don?t see them as interchangeable. A study by Ariely shows that when contemplating the purchase of a $15 pen, the majority of people said they would drive to another store 15 minutes away to save $7 ? but they would not make that same effort for a $1,015 suit. The amount saved and time involved are the same, but people make very different choices.
Make the Most of Windfalls
It?s a natural tendency to view unexpected financial gains as a bonus. That money hasn?t been allocated to anything, so why not splurge? But think of the boost that extra income could bring to helping you achieve your goals.
According to the Wall Street Journal, thinking of your goals in real world terms helps you get there faster. Adding $2,000 to a generic ?investment? might not seem so appealing, but now imagine that you?re putting that towards a trip to Rome or a down payment on your dream home. It should become easier to find the motivation to stick to the plan.
Studies have shown that when humans are able to picture older versions of themselves, it's easier to save for the future. Think of the activities that you enjoy doing now -- traveling, dining, spending time with friends -- and think of retirement savings as a way to guarantee you can keep doing these things forever.
It Can Be Done
Regular readers of FMF?s blog will be familiar with his story of how he paid off his entire debt ? including his mortgage. Each windfall gain ? a pay raise, bonuses, income from a side business, and even gifts ? went towards paying down the mortgage.
Regular contributions ? no matter how small ? will make a difference in your progress. Saving a million dollars towards retirement might sound intimidating, but with regular deposits and boosts from your windfall gains, it becomes that much more achievable.
So, when your big tax return comes in, how will you put it to work?
Source: http://www.freemoneyfinance.com/2012/03/turn-your-tax-refund-into-a-solid-investment.html
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