Key insights from experts on how they manage their money

Some of the most frequent questions experts in personal finance get is “I have this money, what do I do with it?” or “How should I manage my money?”. Even when we really want to do the right thing and manage our finances in a way that secures us in the future, the barriers to doing so can put us off and leave us doing nothing. With all the information available to us, it is easy to experience what psychologists call “information overload”: Because we have a limited ability to store information in our memories, exposure to too much of it can lead to confusion, inertia, and bad decisions.

If this sounds familiar, don’t worry. Planning for our future can be hard, but there are many things you can do to give yourself the greatest chance at success. Here are a few basic steps experts recommend to successfully manage your money.


Step 1: Budget and reduce expenses.

The first step to healthy finances is to commit to a budget and reducing unnecessary expenses. Programs like Mint, YNAB or Hellowallet can help you get started setting and monitoring your spending. Find a way to make yourself accountable if you overspend in any category. Behavioral economists have found that the more public you make your commitment, the more likely you are to stick to it. This does not mean you should give insight into your spending habits to your whole social network! Perhaps you have a trusted significant other or a close friend that has access to your account or gets an email warning when you exceed your spending category budgets.

If you really want to commit to controlling your spending, but know it will be challenging, you can also consider adding an incentive to help you build your new habits. One of the most effective incentives we know about may seem slightly counter-intuitive, but that is also the reason it works so well. It turns out that people strongly prefer avoiding losses to acquiring gains. This means that the potential of losing a reward is a more powerful motivation than getting one. This concept is called loss aversion, and it can be leveraged as a powerful motivator to help us stick to our goals. Here’s how it works: Let your trusted partner know about your goal, and give them an amount of money you’d rather not lose to hold on to. If you meet your goal, they give it back. However, if you fail to do so, they can give the money away to their favorite charity.

A recent study demonstrated just how powerful this can be: Mitesh Patel and his colleagues asked participants to walk 7000 steps per day for 26 weeks. For the first 13 weeks of the study, the participants were split into four groups where the only difference was the type of reward they received. One group got no reward, another got the chance of winning $1.40 per day, another received a definite $1.40 per day they successfully reached their step goal, and the last group received a set amount at the beginning of the month but lost $1.40 for each day they failed to reach their goal. In the study, the loss incentive group came out as a clear winner, with people achieving their 7000 step goal about 50% more often than any of the other groups.


Step 2: Build an emergency fund.

Emergency funds are a crucial buffer in the event of unexpected expenses. Yet an annual survey conducted by the Federal Reserve Board finds that 47% of Americans would struggle to come up with $400 for an emergency. Human beings are prone to what is called the “Optimism bias”, which involves believing that we are above average and that misfortunes are more likely to befall others than us. For example, we may believe that we are more financially successful than others, or we may think that it is less likely that we will get sick or be the victim of a crime than the average person. But emergencies can and do happen.

Optimism bias tends to prevent us from taking on preventative measures ahead of time, for example not buying insurance or saving up for unexpected expenses like your car needing important repairs. While researchers are still not sure how to get rid of this bias, or even if we want to get rid of it, building an emergency fund as a safety net gives you the upper hand whatever happens.


Step 3: Match employer-sponsored funds.

If your employer offers 401k-matching or another contribution plan, it should be a priority to contribute as much as you can. This should be done after you have an emergency fund in place, but contributing enough to maximize what your employer will match should take priority over paying down debts. This is because employer matching funds are risk-free, guaranteed returns on your investments at a rate higher that is usually than your debts.

While the gain of compound returns should be a powerful incentive to contribute, a lot of people fail to do so. Remember that the risk of losses can be a more powerful motivator than gains? Reframing your contributions as potential losses may help you to contribute the maximum amount: Instead of saying, “If I contribute the maximum amount, I will gain $X.”, you should think “If I don’t contribute the maximum amount, I will lose $X”.


Step 4: Pay down high interest debts.

When you carry multiple debts, how do you decide which one to pay off first? Some loans have manageable interest rates whereas others, like credit cards and personal loans, can charge interest rates that are through the roof. If you’re carrying high interest debts of any kind, it’s generally a good idea to pay them off as soon as you can. The first thing you need to do every month is to avoid surcharges and penalties by meeting the minimum payment of each loan. Then, you can focus on paying down specific debts more quickly. There are two main methods for paying off your debts:

  • The avalanche method: The most financially optimal way of paying off debts is called the avalanche method. It involves starting with the highest interest debts and moving to those with lower interest only when they are completely paid off. Because this method of payment means that the lender would pay less money overall, it is seen as the rational choice. However, we don’t always behave in ways that optimize our long-term gains, which leads us to the next method.
  • The snowball method: In this method, you start with the debts that have the smallest balance, and work your way towards paying off the bigger debts. Paying off the small debts first can give us a motivational boost as we decrease the number of debt accounts, and many people seem to prefer this approach. However, while the boost we get from paying off our small loans can feel great, it’s not necessarily the best long-term strategy unless the smallest loans is also always the one that has the highest interest rate.


Step 5: Save for retirement

Although people want to save more for retirement, they often fail to do so. Researchers Schlomo Bernartzi and Richard Thaler recognized this gap between people’s intentions and actual behavior, and decided to test a new way of getting people to accomplish their long-term saving goals. In a nutshell, their “Save More Tomorrow” program gives workers the option of committing themselves now to increase their savings rate later (For example when they get a pay raise, a certain amount will be automatically contributed). Once employees join, they stay in the plan until they opt out. This technique is called pre-commitment, and has been shown to be a great way of getting people to behave in accordance with their future goals. The first implementation of “Save More Tomorrow” yielded quite dramatic results: The average saving rates for the program participants more than tripled, from 3.5 percent to 11.6 percent, over the course of 28 months.


Step 6: Save for other goals

So you have your expenses and emergency fund under control, you’re contributing to your retirement accounts and have paid off your debts – Great work! Now you can start saving for other goals: A down payment for a house, a vehicle, college education for your kids, a vacation or early retirement. Through clever management of your money, you are in an excellent position for a secure financial future.


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