long-term

Why You Need to Make Financial Habits, Not Goals

Andrea Cannon — Thu, 02 Feb 2017 10:00:16 +0000

With any luck you're still on track with your financial resolutions and making strides toward your financial goals. While your financial goals may look pretty on paper, they won't mean much until you start building the habits necessary to meet those goals. And if you have already given up on your resolutions, don't fret. Focus on financial habits, instead.

By adopting good financial habits, you are committing yourself to achieving your long-term goals. Once you've begun a habit, it will eventually become second nature, and before you know it, you'll have made real progress toward your goals.

Track Your Progress

In order to ensure you are on the path to meeting your goals, it's essential to track your progress. This means that you need to create habits that allow you to track your progress. In order to develop a habit, there needs to be some form of reward that happens each time you perform the action. After a while, this repetition will form a new habit. This "habit loop" is how automatic behaviors and successful habits are formed.

Recognizing the progress that you've made every week or month by adopting a new habit will motivate you to continue the action. For instance, by skipping your morning cup of coffee, you may be able to save up to $150 per month. Consider placing a reminder of this somewhere you'll see it throughout the day.

How to Form Good Habits

The only way to form habits that stick is through repetition. Forming a healthy habit is great, but the only way that it's going to be effective is if you continually repeat the behavior. In many cases, it can be good to have an accountability partner who can help you meet your goals. In fact, the Dominican University of California found that more than 70% of people who provided a friend with weekly updates on their progress were successful in accomplishing their financial goals.

Develop Habits Early

The earlier you begin developing financial habits, the better chance you'll have of sticking to the habit on a long-term basis.

Setting a goal determines your end target, but it doesn't necessarily set steps to achieve that goal. On the other hand, when you start forming habits, they can create long-term change. Goals can seem like large, looming things at the end of a long tunnel, whereas habits are something that you can begin doing today. By focusing on financial habits, you can form sustainable behaviors that help you meet your goals in less time.

Good Habits to Adopt

There are certain habits that can help you achieve a broad goal. For instance, if your goal is to pay off debt, then you can start by paying more than the minimum on your credit cards every month. By adopting this habit, you can more quickly pay off your credit cards and move on to other forms of debt.

If your goal is to invest more, then you can get into the habit of automatically transferring at least $35 per week into your retirement accounts so that you can become a millionaire by retirement (adjust the numbers for your age and personal retirement goals).

In order to start building healthy habits, you will need to first create a budget to determine how much you can save and how much you can spend on the "needs" and the "wants" in life. Checking your budget every week is a great habit to form. This will help you to determine where you're spending your money and what can be cut from your regular spending.

Automate Your Habits

Saving money can make you happier both in the short and long run, so it's one of the best financial habits to have. However, it can be difficult to save, so it's best to sign up for an automatic savings plan, which can deposit a certain amount into your savings account every month. You can also set your credit card and other bill payments to be paid automatically. By automating your finances, you get a step closer to establishing healthy financial habits.

The Best of Both Worlds

In an ideal situation, you will build financial habits that can improve your financial status for life. You will also focus on your goals and set the achievable steps you'll need to take to reach those goals in less time.

There are a number of evidence-based strategies that show that maintaining your healthy financial habits can help you reach your goals without even thinking about it. Once you have visualized your goals and outcomes, it's important to identify the obstacles standing in your way so that you can create a plan and begin adopting healthy habits that will benefit you for life.

This article is from Andrea Cannon of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Guest Post: Now is the Time to Think Long-Term

Philip Brewer — Tue, 19 Oct 2010 12:00:11 +0000

I've got a guest post up at Get Rich Slowly on why now — when interest rates are very low — is the time to think long-term.

About twenty-five years ago (as an example of long-term thinking), I had a whimsical investment idea: Buy some cheap land and plant hardwood trees. The trees wouldn't be ready to harvest for 100 years or so, but it would have been a cheap investment with (eventually) a fairly large payoff.

It takes a certain perspective to make such a long-term investment. I call it a whimsical idea because I'd never have been able to enjoy the financial return. I was already in my mid-20s at the time. Even if I'd selected the hardwoods for quick maturity, they wouldn't have been ready until I was well into my 90s.

It's related to some of what I've written here before. (In particular, check out How Low Interest Rates Might Save the World and Invest Some of This Cheap Energy.)

Check out Why Now is the Time to Think Long-Term over at Get Rich Slowly.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Living Cheaply for the Long Term

Philip Brewer — Wed, 09 Dec 2009 14:00:07 +0000

Frugality sites are full of advice for cutting your expenses right away. Everybody's got a list of unnecessary expenses, an exhortation not to buy stuff you don't need, and some ideas for how you can get the things you do need more cheaply. Living cheaply for the long term is different. Call it "strategic frugality."

Most people don't really have a goal to live cheaply. Rather, within the constraints of their income and their important long-term goals (like college for the kids and retirement), they want to live as well as they can. The problem is, boosting your living standard at each opportunity makes it impossible to take the strategic actions that let you live better for less. (And once you've got that down, funding your long-term goals gets a lot easier.)

Many of these strategies cost money, which means that they're not an option for someone who's in the midst of a financial emergency like a loss of income or a major unexpected expense. For that, see my emergency belt-tightening post with a bunch of ideas on how you can cut your expenses right now. Living cheaply on a non-emergency basis is different. Living cheaply for the long term sometimes involves spending more money now with an eye toward long-term savings. Many of the basic ideas are pretty obvious, but it's worth putting them all together and looking at the pattern they form.

Strategies

Buy stuff that lasts. This saves money, because you don't need to replace the item as often. It also raises your standard of living, because stuff that lasts is often higher quality.

Buy stuff that reduces future expenses. Things like weatherstripping, insulation, energy-star appliances, a fuel-efficient car, a small motorcycle, or a bicycle can all save on future fuel costs. Doing proper maintenance can save on future repair costs, and proper preventative care can save on future health costs. Tools, books, and classes that enable you to make (or repair) your own stuff can save on future expenses.

Stock up when things are cheap. This saves money, because you're getting the stuff at a better price. It also raises your standard of living, because you don't have to rush off to the store to get something (or else decide to make do without it). As a bonus, it produces huge tax-free investment returns.

Buy things that earn money. That is, invest in things like bonds and dividend-paying stocks. If you can handle the extra work of being a landlord, you can also invest in rental property.

Take care of your stuff. This goes along with buying things that last, but it's a concept that isn't well supported by society these days. It's tough to get things that are made to last — most things are made to break. Still, despite planned obsolescence, most things will last longer with gentle use and many things can be repaired (or kept in service, at least temporarily, despite not working as well as they did when new).

Best practices

When you want something, it's easy to fool yourself into imagining that whatever it is will somehow save money in the long run. (Such as thinking that a home theater will pay for itself in fewer movie tickets or that a fitness center membership will pay for itself in fewer heart bypass operations.) Avoiding that pitfall simply requires being honest with yourself. To that end, here are a few best practices.

Evaluate your budget against your needs. Even among people who have a budget, most simply assume that last year's spending is the benchmark against which they need to compare. Instead, start each budget category at zero. Then, evaluate what you actually need and investigate the cheapest way to fill that need.

Analyze fixed costs. The average household has a bunch of costs that are fixed for the medium term — a lease that runs for a year, a cell-phone contract that runs for two, a car loan that runs for several years, a mortgage that runs for a decade or three. You can often get a better deal if you commit to an expense for a longer term, and a collection of such deals is what adds up to living cheaply. Still, always think twice before buying things that come with monthly fees or that need to be insured, fed, or maintained (unless you can maintain them yourself). The more fixed costs you have, the less flexible your household cost structure becomes — and an inflexible cost structure makes it tough to handle a financial emergency.

Learn how to do things yourself. If your goal is the highest possible standard of living, you probably come out ahead by putting all your time into whatever is your main way to earn money. In the time it would take to change your oil you can earn more than enough to pay someone to change it for you. In the time it would take just to plant a garden you can earn enough to buy a whole summer's worth of vegetables. But if your goal is to live cheaply for the long term, learning how to do things yourself adds a whole category of cost saving options, while at the same time recovering some of the flexibility you'd otherwise lose to fixed costs.

Having said all that, a lot of keeping costs down is just spending less. If you don't do that, none of this other stuff is going to add up to much. Still, there are certain opportunities where spending a little more up-front, or committing to spending for a little longer, can save money. The key to living cheaply for the long term is cranking the numbers to figure out which option is cheapest — and then, of course, taking action in accordance with what you figure out.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Optimize Your IRA and 401(k)

Philip Brewer — Wed, 29 Jul 2009 20:00:11 +0000

Your IRA and 401(k) (or 403(b) if you work for a non-profit) are great tools for deferring taxes, and have other advantages as well. But because they're labeled "retirement" accounts, people are much too likely to put the wrong investments in them. Here's how to use them correctly.

Because of rules designed to discourage people from taking money out until they approach retirement age, people assume that they ought to put their "long-term" investments in their 401(k). But that's the wrong way to think about it.

The key difference in a 401(k) or IRA account is not that it's supposed to be for your retirement. The key difference is that money that goes into the account--and money earned in the account--is tax deferred. If you let the fact that the accounts are called "retirement" accounts influence what assets you hold in them, you're unlikely to make maximum use of their key feature--and that amounts to throwing money away.

Use that tax deferral!

There are two steps to optimizing your various retirement accounts. The first is to get some money into them, and the second is to put the right investments into the right accounts.

First of all, you probably want to put as a big chunk of your regular income into your 401(k), as you can.

I say "probably" because there are a few reasons why you might want to limit how much money you put in your 401(k):

Your income is very low. If your income is low enough that you're being taxed at 10% or less, there's a pretty good chance that you'd pay higher taxes when you take the money out of your 401(k) after retirement.
Your income is very high. Both the IRS and your company limit how much money you can tax defer if you have a very high income.
Your employer's plan is crappy. Some plans have high fees or poor choices of investments.
You want to save money outside the plan, such as because you want to use it before you're retirement age.

Of course, if your company still provides a corporate match, that plays into the decision as well. I've got a post on when NOT to put money in your 401(k) that talks about those issues in some detail. To what I'd say there I'd only add that federal income tax rates are currently at generational lows. That, combined with the current level of the deficit, suggests to me that future tax rates are likely to be higher than current tax rates--another reason why you might not want to put all your long-term savings in your 401(k).

Separate asset allocation from account selection

The allocation of assets among your various long-term goals is a completely different step from the selection of which account should hold which asset. Understanding this can add substantially to your wealth.

You probably have several long-term goals. Retirement (including early retirement) is one, but anything that requires years of saving qualifies as a long-term goal. (Examples: college savings for a young child, money to start a business, your dream home, a round-the-world cruise).

Investments for all your long-term goals can and should be managed together. All your assets support all your goals; you just confuse yourself if you start thinking that these stocks are for retirement while those other ones are to put a new roof on the house someday.

So, step one is to figure out your ideal asset allocation. This probably includes putting a large fraction of your investments in a broad-based, low-cost stock index fund, but may include investments in many other asset classes: mutual funds that invest in foreign stocks or dividend-paying stocks (or direct investments in such stocks), bonds, real estate, gold, silver, other commodities, etc.

Only after you've figured out how you want to invest your entire portfolio do you want to figure out which accounts should hold which investments.

Choosing compartments

The key to this step is to put income-earning investments in tax-deferred accounts.

Your asset allocation may include an investment in non-dividend paying stocks. They'd be part of a long-term investment strategy whose purpose is to produce growth over the next 20 or 30 years--but just because they're long-term does not mean that they should go in your 401(k)! Quite the reverse: a non-dividend paying stock that's a core holding in your portfolio should be in your regular brokerage account. If it does well you can go on holding it for years and years and won't have to pay any taxes until you sell--and when you do sell, you'll owe taxes at the low capital-gains rate.

Holding that investment in your retirement account would be crazy. First, since you already don't owe taxes while you're holding it, you'd get no benefit from the tax deferral. Second, when you withdraw money from a retirement account you have to pay taxes on it as regular income--losing the favorable tax treatment for capital gains.

(It doesn't work out any better if the investment does poorly--in your regular brokerage account you can use a capital loss to offset other gains before paying taxes, but losses in a retirement account are just losses.)

You don't want the compartment decision to drive your asset allocation--you already decided what investments you wanted to hold. But those assets should end up in compartments based on tax considerations. Interest-earning investments like bonds go in tax-deferred accounts. So do investments with frequent turnover--if you make trades in your regular brokerage account you have to pay taxes on your profits every year.

Dividends are a special case. Currently dividends are receiving favorable tax treatment, so you're probably better off keeping most dividend-paying stocks outside of your 401(k) at the moment. This is likely to change, though, so you'll have to monitor the situation.

If you have a good 401(k) plan with lots of low-cost fund choices, it should be easy to hit your target allocation with most of your interest-earning investments (and investments that you might trade actively) inside the plan.

Limitations

In an ideal world it would be straightforward to allocate things to the different categories: You'd put the things that earned interest into your 401(k) and IRA while keeping things that produced capital gains (and currently dividends as well) in regular accounts.

In the real world there are a bunch of constraints on that, the biggest being that many people, especially younger folks, have practically their whole wealth concentrated in their 401(k).

This happens almost automatically: You get a job, you direct enough money into your 401(k) to get the full corporate match (back when companies actually paid a corporate match), and then you spent most of your take-home pay. You can't hold your stock portfolio in your brokerage account (where you'd get the maximum tax advantage of the capital gains and dividend tax breaks) because you just don't have enough money outside the 401(k).

This and similar real-world considerations are going to limit your ability to get this exactly right--and that's to be expected. The important thing is to base your asset-allocation decisions on your best analysis of your goals and your expectations for the future. Below I've got a few tips for dealing with specific situations.

The main limitation on your ability to optimize your 401(k) plan has to do with the choices your employer offers within the plan. Happily, you can work around even a pretty mediocre plan's limitations, as long as you at least some of your long-term savings outside your 401(k).

First, take a close look at the investment choices you've got and compare them to your desired asset allocation. Maybe there's no bond fund, but there is a balanced investment fund that's half-and-half stocks and bonds. If you wanted 20% in bonds you could get that by putting 40% of your money into the balanced fund. (That would also put 20% of your money into stocks--which is fine, as long as your stock allocation is at least 20%, which it probably is.)

Second, where you really can't find the investments you need within the plan (no international fund, perhaps, or no gold fund) you have to cover that fraction of your asset allocation elsewhere--which is also fine, as long as you have some of your long-term investments outside the plan. If the investment is one that ought to be tax-deferred, see if you can't buy the appropriate asset within an IRA.

Generally, make hitting your asset allocation your number one priority. Maximum tax efficiency is a secondary consideration--but to the extent that you can keep your bond investments (and any investments where you make frequent trades) inside a tax-deferred plan, you'll come out ahead.

As a secondary matter, start saving some money outside your 401(k). As the sum grows, use it to invest for capital gains (and, for however long they remain tax-advantaged, dividends)--and simultaneously shift your 401(k) toward interest-earning investments that make maximum use of the 401(k)'s tax advantages.

For most people this will probably be a long-term problem: Unless you become quite wealthy, your 401(k) will always be larger than the amount of money you want to hold in bonds. But that's not a big problem. Just stick with your asset allocation and emphasize capital gains and dividends outside the 401(k).

Using a Roth

A Roth IRA is a special case. If you follow the rules (wait until your Roth is 5 years old and until you're 59-and-a-half), you can avoid paying any taxes on money earned in a Roth.

The upshot is that most of these issues don't really apply to a Roth. Just invest according to your asset allocation and don't worry about it.

Remember that tax rates always change (and everyone's individual tax situation is different), so be sure to check and understand how the rules will actually apply in your case.

Whatever mix of retirement accounts you end up using, don't let the fact that they're called "retirement" accounts distract you from the essential features that distinguish those accounts: the tax advantages. Taking maximum advantage of those features can add significantly to your wealth over the next few decades.

[Update 6 August 2009: This post was included in the Carnival of Personal Finance.]

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Plan for your wants

Philip Brewer — Sat, 27 Dec 2008 21:15:15 +0000

Budgets tend to focus on needs--food, shelter, heat, light, transportation, and (of course) taxes. They also provide for wants, but generally the smaller, shorter-term wants--cable TV, a magazine subscription, an occasional restaurant meal. Instead of a budget line, the larger, longer-term wants are covered implicitly when your budget spends less than all you earn. Somewhere, though, those big, long-term wants deserve a plan.

Having a long-term plan to satisfy your wants is an important tool for keeping your budget focused on your needs. Satisfying a few of your little wants is what makes your life luxurious and splendid, but it's very easy to let the amount of little luxuries in your life grow until they devour the surplus that might have paid for the big luxuries.

That's where a plan comes in.

Make a list. Or several lists. Brainstorm with all the members of your family. There are the wants that are almost needs--sending the kids to college. There are the wants that are perfectly affordable, if you make them a priority--a house with a yard. There are the wants that can wait a long time, if that's what it takes--a round-the-world cruise. There are the wants that you may never satisfy, unless careful planning meets extraordinary good luck--a racing yacht. Write them down and sort them in different ways.

You can produce a strictly ordered list, with the most important want at the top, and then knock them off one at a time, if that's how your mind works. Alternatively, you can put just the top three or four wants in a "this year" list, with the rest of the wants in no particular order on list marked "the future." Maybe the cheap wants go on one list and the expensive wants go an another. Find a way that works for you.

These lists do several things:

They remind you, when you're tempted by a transitory want, what your important wants are.
They help you structure your spending when you get a windfall. Maybe the next item on your want list is where that money should go. Or maybe it should be invested against some larger want that's further down the list.
They help you structure your spending when see a sale on something you want. If a great price makes one of the top items on your want list affordable, maybe you should just buy it. On the other hand, if the price isn't all that great, or the item isn't near the top of your list, maybe you shouldn't.

If you include some cost notes in your list, you can estimate just how far off the fullfilment of any particular want might be--and you can compare them to one another. How much sooner could you take your trip to Fiji if you quit eating lunch out every day? If it just means you could go in August rather than February, maybe keep the indulgence. On the other hand, if it means you could go next year instead of three years from now, maybe those lunches out are costing you more than they're worth.

Making and maintaining these lists, by the way, is a good deal of the fun. My wife and I are contemplating renting a garden plot from the local park district and have reached the list-making stage. It's a small want--use of the plot from April to October will cost $20--but there's plenty to plan. We need to investigate what grows well here and then match those possibilities with what we want to grow and what we want to eat. We'll have to buy (or acquire some other way) a few tools, some seeds and some seedlings. Now, at the turn of the year, is the time to read books on gardening.

Depending on your nature, these lists might change all the time, or they may be quite constant from year to year. Not too long ago, I came upon a list of wants I'd made in my last semester of college. I'd just become interested in money and investing, and one thing on the list was an expensive subscription to a financial newsletter. I remember that I did get that subscription. I read (and reread) those articles for several years in the early 1980s--a want satisfied with pleasure that I remember with great fondness. (And stuff I learned in those articles informs my writing here to this day.) Also on the list, though, were wants I'd long forgotten. Some I'd satisfied along the way, but that I don't remember with any special pleasure. Others I'd forgotten without them ever having made it to the top of the list. Looking at old lists of wants can give you real perspective when you start feeling like you've got to have the top item on your current list right now.

It's your plan; use it however you like. Maybe you want to put one big want--a sports car, a two-year sabbatical, a cottage by the lake--on the top of the list and focus on it to the exclusion of all else. Maybe you want to juggle many large and small wants in one big list. Maybe you want two lists, one with the small wants and one with the big wants. However you structure it, though, remember that its purpose is to support your budget. The plan to satisfy your wants is what you come to when you're tempted to blow out some line item on your budget. Look at your list. If this is something that belongs right at the top, then scribble it in there. If not, scratch it in wherever it goes.

Then, live that way.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: