I love it when a Nobel Prize winner gives humanity a gift everyone can use and enjoy. That was the case when Prof. Richard Thaler won the Nobel Prize in Economics on Monday (October 9, 2017).
Prof. Thaler’s work over the past 30 years has changed the way we view financial decisions. As a behavioral economist, he’s studied the way we actually think and act instead of hewing to some wrong-headed theories.
According to Thaler’s view, we’re consistently misled by embedded mental biases. We’re hardwired to be overconfident, act on emotion and conflate recent events with the big picture.
Fortunately, thanks to the research of Thaler and other behavioral economists, we can make much better financial decisions. Here are four suggestions:
— Put Your Savings on Auto-Pilot.
By defaulting employees into a 401(k) with regular, automatic contributions, Thaler’s “Save More Tomorrow” program dramatically increased retirement savings.
It turns out when you don’t have to make a decision — or have to say no to something — people will take the easiest route to set money aside.
Yet you can put any form of savings on auto-pilot. Simply set up automatic withdrawals from payroll or checking accounts into savings or retirement accounts.
— Blast Past Your Biases.
Behavioral economists have repeatedly shown that we’re naturally biased to think we know more than anyone else, are needlessly confident, can look back in time and claim we can predict the future.
All of these biases cause us to consistently lose money.
If you need to invest in the stock market — all of us need to in order to beat inflation — regularly invest monthly amounts in global stock index funds. You can do this through any mutual fund, IRA or retirement plan.
— Forget the Headlines.
We all get spooked by daily market downturns and bad news. It scares us, so we think we have to do something immediately. We don’t. Never act on fear when it comes to financial decisions.
If you need to invest — who doesn’t? — focus on how much you need to save. Don’t look at returns or stock averages from day to day. It’s just noise. Buy all the time and hold.
— Don’t Get Cocky.
So you picked a stock or mutual fund that made money. Do you think you have more skill, insight and trading ability than the best money managers— and their lightning-fast computer programs? You don’t. It was the roll of the dice.
Diversify your portfolio by investing in large, medium and small-company stocks from around the world.
That’s always been the smartest thing to do. And you don’t need a Nobel Prize to profit from that knowledge.