In my latest Yahoo!Finance column I interviewed Sheena Iyengar, Columbia business school professor and author of The Art of Choosing, which looks at how people can make better choices. I asked her why she thought consumers make poor financial choices.
“Money is supposed to be meant for exchange but it’s come to be much more than that,” Iyengar says. “There is so much more baggage associated with it; we judge people based on how much or how little they have, or how they use it.
“We expect people to know how to be organized about its distribution in their lives but we don’t give people any training,” she continues. “On top of that, money is no longer tactile and concrete. It’s become something quite abstract and that becomes harder for us to see and experience its growth and shrinkage. When you put something on a credit card it feels very different than using cash. I think all of those things are involved when you decide how to spend your money.”
Another problem is the sheer number of choices. In a study for Vanguard, Iyengar found that the more investment choices a company 401(k) plan offered, the lower the participation rate among employees. Participation rates fell from a high of 75 percent for the smallest plans, which had four funds, to 70 percent for plans with 12 or more funds. When the number reached 30, participation began to slide again – to a low of about 60 percent for plans with 59 funds.
“It’s easy to sign up on the spot when you have only five choices, but when you have 50 it seems reasonable to mull things over for a while,” Iyengar writes. “Unfortunately, as you keep delaying the decision, and days turn into weeks, and weeks into months, you might forget your 401(k) altogether.”
If this is your situation, try the following simple steps:
1) Ballpark your retirement needs using this calculator from ESPlanner.com, a tool created by Boston University economist Laurence Kotlikoff. (It takes about a half hour to complete.) Don’t balk at doing the exercise because you’re concerned you can’t achieve the goal. Darthmouth economist Anna Maria Lusardi has found people who make an attempt to estimate their retirement savings goal ultimately save more than those who don’t – so the effort is worth your while.
2) Try to gauge your tolerance for risk using a tool like this one, from Rutgers University.
3) Bring the results of the two steps above, and the list of your 401(k) investment options, to a fee-only financial planner who charges by the hour to help you choose funds. You can find one at garrettplanningnetwork.com or napfa.org. Budget $100 to $200 for the effort.
4) Once you know how you’d like to allocate your savings, set a timetable and a specific date for executing on the planner’s suggestions so you don’t let it slide. Contribute at least enough of your salary to get any match the company may offer. (I personally max out my retirement contributions.) If you can’t afford the max, make a commitment to increase your contribution by 1 percent every time you get a raise.