Stick with your financial diet

By Carolyn Bigda, Money Magazine


(Money Magazine) -- If there's one thing to thank this miserable recession for, it's that a lot of us are now much more thoughtful about our finances than we used to be. These days, Americans are padding their emergency funds, trimming expenses, and reducing risk in their portfolios.

Just one problem: With the worst of the recession seemingly over, history suggests that many of us will soon revert to boom-time bad habits. People grow overly optimistic about their circumstances in periods of economic growth, says Meir Statman, a behavioral finance expert at Santa Clara University.

fighting_fat_weight.03.jpg
CDs & Money Market
MMA 0.37%
$10K MMA 0.33%
6 month CD 0.35%
1 yr CD 0.67%
5 yr CD 1.38%

Find personalized rates:
 

Rates provided by Bankrate.com.

As stock values rise, home values tick upward, and joblessness falls, we feel richer. Therefore we tend to save less, spend more, and invest more impetuously -- a phenomenon known as the wealth effect. So, ironically, a recovery poses real risks to your financial security.

What you need: ways to trick yourself into staying on track. And with the effects of the downturn still palpable, now's the time to implement such strategies.

Risk no. 1: You'll lose saving fervor

Like most U.S. households, yours is probably squirreling away more money now than in, say, 2005. Think you've been scared straight? Unlikely. We tend to forget the bad times once the good times arrive. As evidence, consider that the personal savings rate often falls following recessions.

How to keep socking away: Undermine your optimism bias by making saving automatic: Have a portion of income deposited directly into savings. It may also help to remind yourself why you're saving. So give your accounts names based on when you'll tap them, suggests economist Tim Harford. Call your cash cushion the if-I-lose-my-job fund. Brand your vacation account Alaskan Cruise fund. "We find it easier to visualize consumption than to just save," he says. Plus, you're less likely to spend money designated for a specific use.

Risk no. 2: You'll go spending crazy

Back in the boom, who didn't buy things they later regretted? You've probably been more scrupulous with spending since the credit implosion. But as your money-anxiety wanes, so too might your self-restraint.

How to stay frugal: Imagine that the money you intend to spend is cash in your wallet, says Michael Pompian, author of "Behavioral Finance and Wealth Management." When buying a $20,000 car, shelling out $100 more for splash guards may feel like nothing. But think about how else you could spend that (gas for two weeks?). Then make your decision.

That said, "self control is like a muscle," says Yale finance professor James Choi. "If you exercise it too much, it gets tired." So also allow yourself a set amount of mad money per month to spend at will. Once it's gone, avoid window-shopping.

Risk no. 3: You'll chase performance

Our tendency to interpret recent experience as the norm can also be dangerous from an investing perspective. Before the bust, it seemed like home prices would always rise. (Ha!) Now emerging markets look like a constant. You said you wouldn't get caught up in next big thing, but ...

How to keep a cool head: Let yourself have 5% of your portfolio to indulge in "opportunities." And create a written investment policy for the other 95%. "Think of it as a binding contract between you and your money," says Colorado Springs financial planner Allan Roth.

Spell out goals and your strategy for reaching them, including asset allocation. When feeling wooed by, say, a Chinese yuan ETF, force yourself to rewrite your policy -- in the time it takes, you may regain your senses. After all, says Statman, "you're probably better off following an investment policy than your instincts."  To top of page

Frontline troops push for solar energy
The U.S. Marines are testing renewable energy technologies like solar to reduce costs and casualties associated with fossil fuels. Play
25 Best Places to find rich singles
Looking for Mr. or Ms. Moneybags? Hunt down the perfect mate in these wealthy cities, which are brimming with unattached professionals. More
Fun festivals: Twins to mustard to pirates!
You'll see double in Twinsburg, Ohio, and Ketchup lovers should beware in Middleton, WI. Here's some of the best and strangest town festivals. Play
Overnight Avg Rate Latest Change Last Week
30 yr fixed4.29%4.30%
15 yr fixed3.23%3.29%
5/1 ARM3.33%3.45%
30 yr refi4.26%4.27%
15 yr refi3.20%3.26%
Rate data provided
by Bankrate.com
View rates in your area
 
Find personalized rates:
Index Last Change % Change
Dow 16,912.11 -70.48 -0.42%
Nasdaq 4,442.70 -2.21 -0.05%
S&P 500 1,969.95 -8.96 -0.45%
Treasuries 2.46 -0.03 -1.16%
Data as of 7:30am ET
Company Price Change % Change
Frontier Communicati... 6.79 0.85 14.31%
AT&T Inc 36.59 0.94 2.64%
CenturyLink Inc 39.90 2.19 5.81%
Bank of America Corp... 15.34 -0.16 -1.03%
Apple Inc 98.38 -0.64 -0.65%
Data as of Jul 29

Sections

McDonald's in Japan says profit and sales will fall short of expected targets this year, as fallout widens over a major food safety scandal. More

Amgen is the latest to continue corporate America's cost cutting strategy, even as the economy is supposedly on the mend More

Bunch o Balloons allows multiple water balloons to be filled at once. Parents are loving it -- to the tune of $645,000. More

Steve Mason, a pastor from California, inherited more than $100,000 in student loan debt when his 27-year-old daughter died suddenly in 2009. With interest and late penalties, the debt has since ballooned to $200,000. More

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.