January is generally seen as a time of renewal, recommitment and change. We enter the new year with the best of intentions, and sometimes even act on them for a little while. The gym is packed, nobody will touch dessert, and we vow that this is finally going to be the year that we get our financial house in order.
Yet, slowly but surely, our resolve falters. To understand why, evaluate how the mind works when it comes to achieving goals. It’s a constant war between our advanced mind (the prefrontal cortex, mainly) and what I call our “monkey brain,” comprised predominantly of the limbic system. The monkey brain likes gratification now and doesn't really care about the future. If it ran the show, you’d spend every paycheck as soon as possible, max out your credit cards and assume the future would take care of itself.
Our monkey brain loves new year’s resolutions! They’re a promise to do something unpleasant later; an opportunity to tell yourself that you’re going to change your behavior without actually changing it. You avoid triggering the pain centers in your brain and everyone is happy, except, of course, your future self who is left to deal with the consequences of your actions and inactions.
So, before we get to the task of setting new goals, we have to understand how to make them stick. A study by professors Dilip Soman and Min Zhao of the University of Toronto shows that when we set multiple savings goals, we tend to be distracted and scatter our efforts between them, decreasing the likelihood of reaching any at all. Instead, focus on one saving or investment goal at a time. Achievement of each builds momentum and increases our positive mindset about the next. After all, it’s better to achieve one goal than to fail at many.
The second part of making a goal stick is creating a habit and measuring your progress. Nike created one of the largest experiments in the fitness world with its Nike+ app. Some 1.2 million people signed up, and Nike discovered that there were two key factors in getting people to commit to regular exercise. The first was actually exercising five times. The number five seemed to be the tipping point for getting a habit to stick. The other requirement was measuring personal data. People who checked how they were doing (how far they were running, or how fast) got hooked into seeing their progress and striving to do that much better.
With that in mind, here are three investing resolutions in a specific order so that you can tackle reasonable goals, and achieve them before moving on to bigger tasks.
Rebalance your investment portfolio. This is not meant to be a time-consuming exercise. I use the rule of thumb of “110 minus your age” to determine the percent of your portfolio which should be in equities versus bonds (though if you’re retired, you may not need bonds). I use basic index funds across a few classes and don’t overcomplicate things. As Professor David Swensen of Yale notes in Unconventional Success: A Fundamental Approach to Personal Investment, proper rebalancing can add 0.4 percent to your annual returns.
What about the uncertainties (the fiscal cliff, uncertain dividend taxes, the rise of China, debt in Spain)? All of these tempt you to react to the news and invest to counteract whatever is getting financial gurus frothy. Yet, actively managed funds—the ones which are supposed to be taking all of this into account in their investing strategies—consistently underperform index funds. Sometimes simplicity is beautiful.
How to make this work: Write out an invitation to your spouse to join you for your annual rebalancing. Pick a date and put it in the calendar. Then sign it at the top. This is key. As Duke’s Dan Ariely points out, you’re more likely to commit to something when you sign at the top of the document. Then, on the appointed date, do it. Make it fun. Reward yourself with a glass of wine or a favorite snack to make it enjoyable. You want to include your spouse because it’s important that both of you know what the investing game plan is in case one of you gets hit by the beer truck. Plus, the more numerate the couple is, the better they tend to perform financially.
Check your credit report for free. Don’t fall for the guys with the band singing the song about credit reports and wind up paying to get some credit monitoring service. Go to annualcreditreport.com and get a free credit report. You’re looking for discrepancies, late payments, and identity theft. If you find something wrong, dispute it. If there’s a ding against your credit, work to fix it by paying off your debt and paying your bills on time. Improving your credit score can make you eligible for lower interest rates on your debts. Lower interest rates on your debts frees up more money for you to invest.
How to make this work: Again, set a date, sign a plan with your spouse and follow through. This might take a little bit longer because you need to check scores from several credit reporting agencies, and cleaning up any negatives will take a little while (though don’t pay for a credit repair agency to “clean up your credit.” The only thing they clean is cleaning out your wallet).
If you do this in January, that’s two wins under your belt, and you’ll be ready for a bigger goal. Here’s a third:
Increase contributions to retirement plans. As Scott Holsopple recently pointed out, 401(k) investment contributions increased to $17,500 in 2013. The IRA contribution limit has increased to $5,500. If you’re not maxing out your contributions already, then going from current contributions to maximum contributions may cause quite a shock to your system and keep you from committing to the plan long term.
How to make this work: If you are eligible to contribute to a 401(k) plan and your plan sponsor offers it, use automated options to slowly increase your contributions. If not, submit paperwork to change your contribution every three months, increasing it a little each time. If your retirement savings options consist of an IRA, set up automatic contributions so that every three months you’re increasing the amount you put in. Also, set up the contribution to occur a few days after the first of the month, and set a calendar reminder on the last Sunday of the month prior to remind yourself that a withdrawal is coming, and that you need money in your account to cover those contributions. By taking this slow, incrementally increasing approach, you’re utilizing a psychological phenomenon called hedonic adaptation to your benefit. Usually, hedonic adaptation is negative. You get a new car, but then want a new convertible, for example. It also works in reverse. In a short time, you'll adjusted to having a little less spare cash in the bank.
The third resolution may take all of 2013 to implement, but by this time in 2014, you’ll be in better financial shape than you were when you made the resolutions, and you’ll have pulled a fast one on your monkey brain at the same time.
Jason Hull is a candidate for the CFP(R) Board's certification, is a Series 65 securities license holder, and owns Hull Financial Planning.