We all have financial goals, and a smart way to reach them is by developing a sensible plan. If you are already an avid saver, congratulations; keep doing what you are doing. But if you know you need to improve your money management skills, take heart: They will improve with a little discipline.
Consider the following tips for creating a successful financial plan:
Changing your mindset from a spender to a saver is the first step, and recording your financial dreams in a journal can show you what and how you think financially, which is key to changing behavior. A journal helps crystallize your real wants and needs, and it may also reveal personal disappointments or doubts that might be interfering with your financial discipline. As your writing reveals these influences, you will steadily gain more control over unhealthy spending urges, and you will become more determined about your goals.
Define your financial goals using clear, personal words rather than abstract definitions. For example, say “I want to eliminate credit card debt within three years,” “I want to build a $10,000 emergency fund,” or “I want to retire in 12 years.”
If sorting out your goals becomes difficult, try distinguishing your wants from your needs. Also try prioritizing your goals by time horizon. For example, you can place your goals in three broad time horizons: short-term (one to three years), intermediate (three to 10 years), or long-term (10 or more years). You may shift your priorities later, because goals and their importance vary with circumstances.
Once you identify your goals, look ahead, set a deadline for making them happen, and mark them on a calendar.
Now you can begin “making them real,” and this is where budgeting comes in. You will need to find a way of allocating your limited dollars among several competing goals. To get started, track your earnings and expenses by doing a cash-flow analysis. Several A&M System ORP and TDA vendors have online savings calculators to assist you in this process. You can also find financial calculators on the Securities and Exchange Commission (SEC) website. If you notice that too much of your budget goes to eating out, entertainment, clothing, traveling or electronic toys, simply cut back in those areas.
Once you’ve developed a strategy for increasing your savings, invest as much as you can for retirement. A good way to do this is to contribute as much as you can to a supplemental retirement program, independent retirement account (IRA) or other savings vehicle. For a description of A&M System-offered supplemental retirement programs, as well as IRAs, see sidebar.
When you are investing for retirement, you want to contribute as much as you can. You also want to ensure that your asset allocation—the percentage of money you place in stocks, bonds, mutual funds, real estate and money market—is appropriate for your risk tolerance, or the extent to which you can tolerate volatility in your portfolio. Asset allocation plays an important role in determining the risks and returns of your portfolio.
Understanding the three common types of behavior that disrupt asset allocation—overconfidence, loss aversion and present-biased preferences (see sidebar)—can help you avoid them, or at least avoid engaging in them excessively.
How to recognize it: Overconfidence can be noticeable in frequent trading or in switching between investment accounts in an attempt to increase returns. It can result in a tendency to sell “losers” at low prices and buy “winners” at high prices, failing to produce the desired effect and actually moving you farther away from achieving your goals.
Overconfidence increases your transaction costs, the potential for higher tax liabilities, and the possibility of selling your securities just when the market rises. Generally, investors who overtrade tend to make more mistakes than those who stay the course.
How to cure it: Develop realistic expectations and try to curb skewed performance assumptions by studying historical returns for specific investments and asset classes. Research will show that certain investments offer potentially higher returns because they carry more risk, which may be fine if you understand and accept the higher risk of losing money with these securities. This awareness can help you establish an appropriate asset allocation strategy that is realistic for your goals.
How to recognize it: Loss aversion has to do with how you feel about losing money. Essentially, one’s disappointment over losing money is stronger than one’s joy over making it. While it’s perfectly normal to want to avoid losses, excessive fear of loss can hurt investment prospects. For example, some investors react to immediate stock fund losses by pulling money out of their accounts or funds with the idea of reinvesting it when stocks become less volatile. The problem is that this can result in a systematic “buy high and sell low” strategy that can lead to lower returns and greater risk.
How to cure it: Make sure your investment decisions are in line with your long-term goals. For example, if you reduce your exposure to stocks because the market goes from bull to bear, make sure your adjustment is part of your financial strategy and not just a reaction to the market.
How to recognize it: Present-biased preferences has to do with focusing on short-term financial events at the expense of your long-term needs. For example, if you give people the choice between receiving $100 today or $110 next week, some will take the $100 now. But if you offer the same people $100 in a year or $110 in a year and a week, they almost all opt for the $110. This illustrates that we often put too much emphasis on getting something now, even when it’s not always the best choice. You can identify this behavior by a lack of commitment to saving regularly and by acts that interfere with good budgeting. Another sign of this behavior is procrastination.
How to cure it: Create a savings/investment plan and periodically check to see if you’re saving enough for your goals. To strengthen your commitment, you should use “forced savings” tactics, such as enrolling in employer-sponsored programs like the TDA or DCP plans, where contributions will be a specified percentage or amount of your salary every month. For your IRA, after-tax annuities, individual investment accounts and savings accounts, set up an automatic investment plan where a fixed amount is withdrawn from your checking account and deposited into your product account on a selected date.
As you commit to your financial plan, you’ll start to realize that achieving and maintaining financial success is a process. You will learn to become more focused, and you will realize that planning is not a one-time exercise. You might even adopt the philosophical view, “since it took time to develop these unhealthy habits, it will take some time to acquire the healthier ones, too.” Just know that the changes you make can pay off.
This article is part of an ongoing series of articles regarding retirement
savings. The information has been provided by various A&M System
ORP and TDA vendors. 