3 Powerful Ways To Retire Rich
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Sometimes doing the right thing financially is simple. But we often focus on the wrong things and get distracted from our goals.
You might think, for example, that the Federal Reserve raising interest rates, which it did recently, is a big deal. Sure, it will hike rates on credit cards and mortgages, but it probably won’t impact your life in any significant way.
The list goes on for financial distractions. Yet when it comes down to it, you really need to concentrate on what’s important to your short- and long-term goals.
One of the men most responsible for informing us on how we get distracted by outside information and internal biases is Daniel Kahneman, a Princeton professor who won the Nobel Prize in economics. His book, Thinking Fast and Slow, is a 21st Century classic and a must-read.
What makes Prof. Kahneman worthy of global recognition is his research into how we make decisions. Unlike the canon of most of classical economics, we rarely act in our own best financial interest. We rely upon emotions and frequently lose money doing so.
Dr. Kahneman, for example, found that we attach heavy emotional weight to taking losses. We will do almost anything to avoid the negative feelings, even when it makes sense. When he was speaking recently at the Morningstar Investment Conference, he expounded on some of his research for some useful insights that will help you build wealth.
— When Do you Feel the Pain? I’m referring to any investment. You get to the point at which you “want to bail,” notes Prof. Kahneman.
That’s a more important benchmark than expected return or the glowing “story” of a stock or other investment. This boils down to being honest with yourself: “How much are you willing to lose?” is the more important question.
— Do you understand the risk? Most don’t. Nothing is guaranteed, except for maybe a Treasury Note, which still can lose money when you subtract inflation.
Prof. Kahneman suggests you employ “broad framing” by balancing present and future risks. Usually that translates into two portfolios or “buckets.”
One bucket is for short-term money for paying bills, taxes and short-term goals like saving for a house. This is money you can’t afford to lose, so you sock it away in federally insured money-market or savings vehicles. If college expenses are looming, for example, you want your money in the safe bucket.
The second bucket is for a longer-term horizon such as retirement. You can take more investment risk — in index stock mutual funds — because you have more time and need to compound returns. You don’t touch it until you really need it.
— Nullify the Noise. This is where you tune out the world and focus on the previous two points. Are you achieving your goals? Are you taking appropriate amount of risk to get there?
Stop reading the business headlines if you’re truly focused on long-term objectives. That way you’ll not only save more than what you need, you’ll short-circuit your worst instincts.
John F. Wasik is the author of “Lightning Strikes,” “Keynes’s Way to Wealth“and 15 other books on innovation, money and life. Follow him on Twitter and Facebook.
