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Behavioral Finance-Anne Tergesen Article
Old 01-20-2017, 09:03 AM   #1
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Behavioral Finance-Anne Tergesen Article

I just read an interesting article by Anne Tergesen (WSJ), which I would link here but, it requires a subscription. If you have one, that's great - go directly to the article. But, if you don't, no worries; I've included a few excerpts below.

I wanted to discuss some points made in her article that resonated with me, and see if they resonated with other E-R.org members. And, perhaps (well, almost certainly around here) get posts on other behavioral finance strategies that have worked for you. The article 'thesis' and three excerpts, with some discussion, are below.

Thesis:
Given a choice between satisfying our immediate needs and desires or focusing on the future, the here and now typically wins out. That impulse doesn’t bode well for retirement savings.

Behavior #1: Think shorter term.

Excerpt: In one of the studies, the researchers divided participants into two groups, instructing one to imagine retiring in 30 years and the other to think of their time horizon as 10,950 days. Even though the time periods are the same, the participants told to think in days reported plans to start saving four times sooner, on average.

Comment: Although I don't remember every having "daily" financial goals, we did have "monthly" goals, which helped quite a bit; it was particularly helpful with after tax savings, as we saw our (old) 'Sharebuilder' account build up.

Behavior #2: Break Down Long-Term Goals

Excerpt: The closer we get to a goal, the more motivated we become, according to the so-called goal gradient hypothesis. First documented in a 1932 study that showed rats in a maze run faster when a reward is in sight, the hypothesis explains why runners pick up their pace as they approach the finish line. To harness the motivating power of an imminent deadline, researchers recommend dividing long-term goals into shorter subgoals.

Comment: This 'finish line' mentality worked very well for me. For the last ~10yrs before FIRE, we measured our NW against an annual goal that would support FIRE at our goal age. The 'Great Recession' happened during that last 10 yrs, and the annual goal was very motivational for us. It prompted us to supercharge savings to help make up for the market losses.

Behavior #3: Monitor Your Progress

Excerpt: Individuals should automate their savings to reduce the temptation to spend. But they should also periodically remind themselves to check their progress toward their subgoals and overarching goals. In a 2011 study, Derek Koehler, a psychologist at the University of Waterloo in Ontario, and two co-authors found that those prompted to monitor their progress are more successful. Among a group of University of Waterloo students with jobs, almost 70% who tracked their progress toward their savings goals when prompted by biweekly emails achieved success, versus 57% in the group that didn't receive the emails.

Comment: Having monthly and annual savings goals that we knew we'd have to measure ourselves against monthly/annually, was a great motivator. For us, this affected primarily after tax savings (which was highly discretionary) because, tax deferred savings was already on autopilot & maxed out. This is related to #2 above.

So, how about you? Did any of these (or other) strategies work for you on your path to FIRE?
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Old 01-20-2017, 09:23 AM   #2
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I believe automation of goal items is the single biggest aid available to people in reaching their goals. People who have money taken directly out of their pay to fund their 401k, for instance, are much more likely to consistently put money away than if they were manually transferring that money to a retirement account.

I have biweekly contributions to my brokerage account and savings account set up as well as paycheck contributions to my 401k. With the contributions automated, I'm much less likely to justify using the money for something else.
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Old 01-20-2017, 10:48 AM   #3
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I agree on monitoring and goals completely. I set my goal based on "lifestyle inflation" i.e. my expenses should not inflate more than 1-2% YoY and I monitor expenses using monthly average every week.
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Old 01-20-2017, 12:01 PM   #4
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I was a regular user of Quicken so I had my Lifetime Plan and could easily monitor my progress towards the goal of retiring early.
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Old 01-20-2017, 04:41 PM   #5
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Originally Posted by Huston55 View Post
... First documented in a 1932 study that showed rats in a maze run faster when a reward is in sight, the hypothesis explains why runners pick up their pace as they approach the finish line.
I doubt that the above is correct regarding why runners pick up the pace as they approach the finished line.
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Old 01-20-2017, 05:10 PM   #6
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Gawd, those three things sound like goal setting exercises at w*rk.

I just enjoyed saving and investing, and never felt the need to conspicuously consume. One day I woke up, and found additional earnings/savings weren't going to move the needle much, and I retired.
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Old 01-20-2017, 05:52 PM   #7
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I doubt that the above is correct regarding why runners pick up the pace as they approach the finished line.


Why do you doubt it?
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Old 01-20-2017, 06:05 PM   #8
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To my mind there is no doubt that behavioral finance issues have helped me become a better investor. There are many books on the subject that have been helpful.

Yes, I set goals back in the 1980s and monitored progress. It is kind of like monitoring progress during an exercise program with weight lifting or running. Small, steady improvments are motivating. Getting nowhere is not motivating.

Even today, I describe in the LOL!'s Market Timing Newsletter publicly what I intend to do because that is a behavioral trick to make me actually do it. I also track performance and the performances of benchmarks to let me know if I am fooling myself or not.

Furthermore, I realize that people fall into behavorial traps that I can take advantage of, so I am looking for those opportunities.
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Old 01-20-2017, 08:58 PM   #9
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Quote:
Originally Posted by Huston55 View Post

Behavior #2: Break Down Long-Term Goals

Excerpt: The closer we get to a goal, the more motivated we become, according to the so-called goal gradient hypothesis. First documented in a 1932 study that showed rats in a maze run faster when a reward is in sight, the hypothesis explains why runners pick up their pace as they approach the finish line.
Quote:
Originally Posted by redduck View Post
I doubt that the above is correct regarding why runners pick up the pace as they approach the finished line.
Quote:
Originally Posted by Huston55 View Post
Why do you doubt it?
Runners employ strategies and one strategy has to do with pacing. Often, if a runner knows he has the race won, he doesn't speed up. If he senses the need to speed up and if he can, he will run faster, but it usually has to do with the opposition and not the closing in on the finish line. I'm not sure that rats use pacing as a strategy. I don't think that the 1932 findings of rats in a maze can be extrapolated to (human) runners.
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Old 01-20-2017, 09:40 PM   #10
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Runners employ strategies and one strategy has to do with pacing. Often, if a runner knows he has the race won, he doesn't speed up. If he senses the need to speed up and if he can, he will run faster, but it usually has to do with the opposition and not the closing in on the finish line. I'm not sure that rats use pacing as a strategy. I don't think that the 1932 findings of rats in a maze can be extrapolated to (human) runners.
Perhaps the runner analogy isn't perfect. While it may or may not hold true for the serious athlete - I know that when I have been in long distance kayak races, I definitely get a surge of adrenaline when I know the finish line is nearing, and especially when I can see it on the horizon. Part of it is because I know I don't have to paddle for much longer and I don't have to budget my energy, and I want to get as good of a time as possible (even though a few minutes doesn't mean much compared to a 64 hour timeline). But part of it is also because I want to get out of the damn kayak and finally finish the race...

And even when you don't use an athletic analogy - imagine if you set up an automatic transfer from your checking account to Vanguard every month to buy an index fund, and simply did that every month for 10 years and never checked your balance. Not once.

Compare that to checking your balance every month (or at least every quarter). Do you think the person checking their balance periodically will have more incentive to stick to the plan as they see themselves inching closer and closer to the goal, compared to the person that never checks and has no clue how close or how far they are from the goal?
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Old 01-20-2017, 09:58 PM   #11
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From my own experience, I think there are benefits to having limits on how automated a savings plan can be. As an example, for many years I had a 401K plan that would stop payroll deductions when the contribution cap was met for the year and the employer match also stopped until the beginning of the next year. Because of variable work hours, it was impossible to just set a % contribution and forget it if you wanted to get close to max'ing the annual limit and not loose matching by hitting the cap early. The extra scrutiny required to hit the goal (cap filled for the year with no match lost) also meant my 401K got examined in detail every fall.

As a negative example, a younger work peer recently asked me to help him with his 401k. He is an 11 year employee and has been contributing 7% for the entire time, just enough to get all the match offered. He had never looked at his account and the entire amount was sitting in the money market fund. Automation had made it too easy to ignore his due diligence.
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Old 01-21-2017, 11:46 AM   #12
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Quote:
Originally Posted by MooreBonds View Post

...And even when you don't use an athletic analogy - imagine if you set up an automatic transfer from your checking account to Vanguard every month to buy an index fund, and simply did that every month for 10 years and never checked your balance. Not once.

Compare that to checking your balance every month (or at least every quarter). Do you think the person checking their balance periodically will have more incentive to stick to the plan as they see themselves inching closer and closer to the goal, compared to the person that never checks and has no clue how close or how far they are from the goal?
Well, I just don't know. I would think that the guy who doesn't check his balance may have a better chance of reaching his goal--he doesn't seem to have a need to be messing around with his portfolio. So, I'm not sure you can measure incentive here. It seems like this person is sticking to his plan and has the incentive to do so. I'm not sure how being closer to his goal would change his incentive to reach that goal.

And, perhaps this person doesn't have a goal other than slamming as much dough (paying homage to RobbieB) into his index fund as he can afford. Would it be against the rules here for the person to increase (if he can afford it) the cash amount of the automatic transfers if he still does not check his balance?
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Old 01-21-2017, 09:09 PM   #13
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Originally Posted by exnavynuke View Post
I believe automation of goal items is the single biggest aid available to people in reaching their goals. People who have money taken directly out of their pay to fund their 401k, for instance, are much more likely to consistently put money away than if they were manually transferring that money to a retirement account.

I have biweekly contributions to my brokerage account and savings account set up as well as paycheck contributions to my 401k. With the contributions automated, I'm much less likely to justify using the money for something else.
100% agreement on this approach. Automation helps to remove the distracting burning feeling you get in your pocket each pay period. We started out contributing the amount needed to max employer match and then lived on what was left over. Each year we'd add the raise the percentage an amount equal to our raises if we got them until we max'ed out. That seemed to be the most comfortable approach for us...
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Old 01-21-2017, 11:40 PM   #14
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This is really cool stuff. I think measuring returns relative to the market would have helped me big time.

I feel like I always focused on increasing my salary/take home pay and making sure my expenses were well below my means. That has worked out great but after having great earnings, I never focused on "Return on Investment". I'm not sure why but I guess I was so focused on increasing earnings, along with fear from seeing the dot com crashes and then 2001 and the last market meltdown, I was way too conservative and kept cash. Luckily, I did some RE as it felt safe but this is food for thought but still struggle with the thought of having more than 50% of my net worth in the market.
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Old 01-22-2017, 06:46 AM   #15
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Runners only pick up the pace as they near the finish line if they have enough left in the tank to do so. I think the more general statement is that the closer you get the finish, the more you can afford to go all out. Sometimes you'll be pleasantly surprised and be able to pick up the pace. Other times going all out will at least allow you to maintain your current pace, or not slow down too much. If you go all out too early, you risk blowing up later in the race. As a fellow marathoner likes to say: "If you don't end up in the medical tent, you didn't run hard enough".
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Old 01-22-2017, 08:16 AM   #16
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I used to run cross country races in high school and as an adult I ran some 10k's up to my 50's. My best races were run by pacing myself throughout the race. These days it's not about winning the race against others but just enjoying the run.

In investing, I've always just gone for the best returns throughout. No let up. But the tools now are spreadsheets and an abundance of data plus time to indulgence my interests. Didn't really have that before ER.

Regarding behavioral finance, I've mostly gotten various ideas second hand by reading what others mention.
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Old 01-22-2017, 09:52 AM   #17
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Originally Posted by MooreBonds View Post
Perhaps the runner analogy isn't perfect. While it may or may not hold true for the serious athlete - I know that when I have been in long distance kayak races, I definitely get a surge of adrenaline when I know the finish line is nearing, and especially when I can see it on the horizon. Part of it is because I know I don't have to paddle for much longer and I don't have to budget my energy, and I want to get as good of a time as possible (even though a few minutes doesn't mean much compared to a 64 hour timeline). But part of it is also because I want to get out of the damn kayak and finally finish the race...

And even when you don't use an athletic analogy - imagine if you set up an automatic transfer from your checking account to Vanguard every month to buy an index fund, and simply did that every month for 10 years and never checked your balance. Not once.

Compare that to checking your balance every month (or at least every quarter). Do you think the person checking their balance periodically will have more incentive to stick to the plan as they see themselves inching closer and closer to the goal, compared to the person that never checks and has no clue how close or how far they are from the goal?
As described in #2 of the OP, this 'finish line' mentality was definitely in play for us as we neared FIRE (last 6 yrs). As I described, we'd laid out annual NW goals for each of the next 6 yrs and knew precisely how much our portfolio had to grow each year to stay on track. At the beginning (year 1 of 6), we made the mental commitment to make up with additional savings any shortfall that might come from market performance. Of course, then the 'Great Recession' came, and our resolve was tested. But, we stayed pretty close to on track, socking away extra $, saving 100% of bonuses, cutting discretionary savings, etc. We lagged a bit in 2010/11 because the downturn was so large that we couldn't make it all up with extra savings but, as the market turned around, we caught up in 2012/13 and FIREd in 2014.

I've run a few marathons & triathlons, and I can tell you that for me, seeing our 'actual' NW bar higher than our 'plan' NW bar was every bit as satisfying as crossing the race finish line.
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Old 01-22-2017, 10:08 AM   #18
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I was fortunate to retire 30 years ago at age 33, before internet forums created all these problems for you newbies.
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Old 01-22-2017, 10:39 AM   #19
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I was fortunate to retire 30 years ago at age 33, before internet forums created all these problems for you newbies.
My ultimate respect!

Must have been hard to run FIRECalc on an abacus.
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Old 01-22-2017, 11:11 AM   #20
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I believe automation of goal items is the single biggest aid available to people in reaching their goals. People who have money taken directly out of their pay to fund their 401k, for instance, are much more likely to consistently put money away than if they were manually transferring that money to a retirement account.

I have biweekly contributions to my brokerage account and savings account set up as well as paycheck contributions to my 401k. With the contributions automated, I'm much less likely to justify using the money for something else.
I agree which is why I like the UK's retirement set up where every employee must have a retirement plan and the default is to make contributions. The employee can opt out, but they have to fill out a form to do that.

There's a lot of common sense in the quotes from the WSJ, stuff that I learned from my Mum because it was necessary to make my Dad's wages last the week. However, you've got to earn enough first and the psychology of saving isn't much use when you know the rent is due and you can't afford food for your kid or their medication etc.
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