If you sometimes feel your rational brain and your irrational brain fighting with each other inside your head, you're probably not alone. In fact, there's an entire branch of economics, known as behavioral economics, devoted to studying why and how we humans make decisions that may not be the best for us.
Recently, the Employee Benefits Research Institute looked at the contributions that behavioralists have made toward understanding why we don't always make the best decisions when it comes to our 401(k) retirement plans.
You've already learned, in the first part of this article, that human nature tends to flow with the status quo. If you've stuck with the default options in your 401(k) because you were automatically enrolled in the savings plan, it's time to take a look at your contributions and investments.
If you've been an active 401(k) investor, you're not out of hot water yet. You have your own set of behavioral quirks to contend with. See if any of these tendencies have caused you to make some less-than-optimal decisions about your 401(k) account.
Hyperbolic discounting. What a great term! It means that we tend to discount the future as less important than the present. It may be one reason, combined with procrastination, that you're not saving the right amount for retirement. Did you pick a number out of a hat when deciding how much of your salary should be set aside in your 401(k)? In a similar trend, some workers just grab some rule of thumb, like the plan's minimum, maximum, or the amount that the guy in the next cubicle's saving. It's time to check out The Motley Fool's retirement calculators and see whether you're saving enough.
Option overload. Does your plan offer dozens of investment options? Researchers have found that the more mutual funds offered, the more likely it is that plan participants will opt for more conservative investments like money market and bond funds. Sound familiar? If you're not investing in stocks through a mutual fund, and you're at least five to seven years from retirement, you're giving up the potential for growth over the long run.
If you're truly stumped by all the options, look for a low-cost equity index that tracks the performance of the S&P 500 or the total stock market. With the latter, invest in a fund like Vanguard's Total Stock Market Index Fund and you'll get automatic diversification across more than 3,700 companies.
Chasing past performance. Apparently those disclosures that past performance does not guarantee future results just don't sink in. Instead of chasing the latest fad, take a look at "4 Rules for Asset Allocation" and develop your own investment plan.
- Familiarity. If there's a fund that's been in your 401(k) for a long time, you'll start to believe it's less risky than other funds available for your investments. You may be right, or you may not. Researchers believe this may be one reason that workers tend to hold onto too much company stock -- they're familiar with the business and believe it's less risky than other options. Give your company stock an objective look and compare it to more diversified funds available in your plan.
Like the workers who simply let their employers make all the decisions on their behalf, even participants active in their 401(k) choices can become a victim of the status quo. A vast majority of plan participants set their preferences and then don't change them. Maybe your original choices were right on the money, in which case change isn't needed. Nevertheless, it's good to occasionally rebalance your portfolio and look over new investment options that have been added since you last looked into your plan.
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