In this How to Reach $1 Million special report, you’ll see how following five cardinal rules of business management can pay off for you personally. You’ll discover how a sensible, businesslike approach to your personal finances can speed up the time it takes to get you into the millionaires’ club.
This story explains how thinking outside the box can take you to millionaire status.
Successful leaders know that the trick to turning around a moribund business isn’t just getting employees to work harder but also getting them to think differently. Sometimes that requires unconventional motivational tactics.
Case in point: To push his staff at Extended Stay America to take risks, CEO Jim Donald recently started handing out GET OUT OF JAIL FREE cards. The goal? To convince employees that they won’t get in trouble for proposing bold ideas that end up failing.
As you work on saving and investing your way to $1 million, there are some behavioral tricks that you have up your sleeve too.
To be a better saver…
Make a commitment. Write down your savings goals or share them with a trusted friend or relative. In her recent research on saving behavior, economist Jill Luoto of Rand Corp. discovered that the mere act of pledging to be a better saver makes people much better at saving.
“People like to be consistent in their words and actions,” Luoto says. “If you make a pledge in front of family and friends, that social pressure enforces your behavior more.”
In Luoto’s study, one group of savers was handed various sums of money and assigned a savings account in which to sock the dough away. Another group was assigned a similar savings account, but its members were also required to visualize their goals, announce how much they’d save, and type out a promise to be a good saver. After six months the group that was required to make a written commitment had put away far more than those who didn’t.
One simple move that can help you emulate their success: Use a motivational app or website such as Stickk.com, developed by Yale behavioral-finance experts.
You can create a contract, share it with others, and even devise a financial penalty if you fall short — say, authorizing a credit card payment to a charity. The site has found that users who share their goal with supporters and elect a penalty succeed nearly 80% of the time, vs. 40% for those who file a goal but keep it private.
Box yourself in. Luoto also studied a third group of savers — people who were assigned an account that barred withdrawals over the next six months. “We thought the scariness of illiquidity would drive people away,” she says. Instead, that group saved far more than the other two.
The lesson? Make some of your savings tough to access. Max out special-purpose accounts that penalize early withdrawals, such as 401(k)s and IRAs for retirement, and 529s for college.
For shorter-term savings, Connie Stone, a Chagrin Fall, Ohio, planner, suggests I bonds, which can’t be cashed in for a year and dun you three-months’ interest if you sell before five years. The bonds are guaranteed to pay at least as much as the inflation rate — more than comparable CDs.
To be a winning investor…
Don’t look back. When managing a portfolio, it pays to forget how much you invested. In a Caltech study, student investors who weren’t reminded of the price they paid for stocks were 31% less likely than folks who knew their cost basis to make trading errors, such as selling winners too soon or holding losers too long.
Other research finds that this common desire to recognize gains and hide from losses — known as the “disposition effect” — reduces investors’ returns by as much as 3.4 percentage points annually.
Study co-author Cary Frydman, an assistant professor at USC’s Marshall School of Business, suggests trying to drown out info about past costs with data about what lies ahead, such as analysts’ estimates of a stock’s true value. The key question to ask yourself, he says: “Will I be able to sell this stock at a higher price in the future?”
Look way ahead. A simple trick to help keep your future focus: Post a chart near your computer showing stock returns over the past 50-plus years, and highlight the periods when the market hit a rough patch. Such charts, says Harvard economist John Y. Campbell, help “remind you the best times to invest often follow periods when people lost a lot of money.”
Think back to the dark days following the October 1987 market crash, when stocks tumbled 30% in just five days. Had you put $100,000 into an S&P 500 index fund then, you’d have a cool $1.2 million today.
Don’t act like a shortsighted CEO by…
…making decisions while brimming with confidence. Research shows that cocksure bosses often make bad acquisitions.
And a 2012 study found that fund managers whose annual reports were full of optimism lagged the market. “If you have a weakness, better that you be underconfident and tentative than overconfident,” says NYU finance prof Aswath Damodaran.