Lessons from financial advisors from doing their work over the years

Over the course of their careers, financial advisors are there for the highs and lows of our financial lives. They have seen people’s successes and mistakes, and although no one can predict the future, they can help us learn from the mistakes that have made others trip up.

1. Not saving enough

According to the Federal Reserve Bank of St. Louis, the average American saves 5.4% of their monthly income. This likely includes all kinds of savings: For retirement, emergencies, college education for the kids or more specific large purchases like a house, car or vacation. The most impactful way of getting in shape financially is to increase this percentage. While it may mean cutting down on non-essential purchases, it doesn’t have to be as complicated as we fear.

A lot of the decisions we make are fast, unconscious and automatic. Our behavior is affected by cues in our environment. Consider for example a familiar situation we encounter every day: We are having a nice meal, and we finish what is on the plate. While the portion may have been too big or too small, we use what was on the plate as a cue to decide what an appropriate portion size is, and we are satisfied when we’ve finished it. Now think about how our account balance could serve as a similar cue: Let’s say we transfer a small amount to savings and pay our bills at the beginning of the month, now the rest is up for grabs! The money in our checking account can serve as a similar cue as the food on the plate: If it’s there, we can use it.

A way of getting around this and helping us save more is to make a larger portion of savings as automatic as possible. When we set up automatic transfers into our savings account, we save time, make each transfer seem less like a painful loss and create a default for saving that we have to actively opt out of if we want to change it. And when the money is out of our checking account and harder to access, we are more likely to adapt to using only what is left in our account.

2. Underestimating how interest compounds over time, for both saving and debt accounts

A common mistake people make is to underestimate how interest compounds over time. Saving $1,000 per month for 40 years amounts to $480,000. But if you compound each month’s $1,000 savings at a 6 percent annual return rate, it increases up to nearly $2 million! With debt, a high interest rate loan can mean making payments but struggling to pay it off as it grows faster than you can handle. Interest rates can seem complex and daunting, but if indebted consumers do not fully appreciate the implications of interest rates, they may not base their decision of which debt to repay on which debt has the highest interest rate. The same is true for savings and choosing the right account to let your money grow.

Our struggle to understand how interest compounds over time is consistent with research on how we make decisions: When attributes of a choice is hard to evaluate, they don’t receive as much weight when we make the decision. The best antidote is to educate yourself about how interest rates work and make informed decisions about which accounts and loans we choose.

3. Forgetting to take advantage of 401k matching

Free money sounds great, right? For most people, it also sounds a little bit too good to be true. That may be why so many of us forget to make advantage of our employers’ 401k matching schemes. If your employer matches the first 10% of your 401k contributions, you should make sure to find a way to hit a minimum of that 10%.

4. Having an illusion of control when investing

There is a bias when it comes to investing that the most educated of my friends seem to be even more prone to than others, and it’s called the illusion of control. It is the tendency for people to overestimate their ability to control events that they actually have little or no control over. Consider the example of Angela. Angela has a doctorate degree in biology and considers herself a smart woman. Wanting to start investing some of her savings in the stock market, Angela spends a lot of time reading up on do’s, don’ts and market trends. Because she is so knowledgeable and prepared, Angela feels a sense of control over the future outcome of her investments. The reality is that no matter how much time we spend studying the complexities of our investments, it probably isn’t going to be as important to the outcome of it as we’d like to think. Gaining more and more knowledge about your investment decisions will probably make you more comfortable with them, but not better at them.

5. Being conservative to a fault

A recent poll showed that only 55% of American adults owns any stocks at all. Stocks can be complicated, because while they are risky in the short term, they are also one of the best ways to grow your wealth in the long term. So why is it that almost half of us don’t own any stocks? In general, people are wired to be risk-averse. When we are exposed to uncertain situations, avoiding risk is a way to reduce uncertainty that has been a useful evolutionary strategy. But while we may tend towards avoiding risk when we can, people have different levels of tolerance for it.

Investing can be an emotional experience, and there’s a lot of factors that are out of your control. No matter how much you need the money, you can’t force the market to keep going up. When you invest, you need to accept that the value of stocks will go up and down, and sometimes significantly down. Even when it seems tempting to sell your stock as it loses value, many people have gotten their wealth destroyed by wanting to avoid risk and not waiting it out. Although it’s hardly a guarantee for the future, historically stocks have favored those who kept a cool head through dips in the market.

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