SET UP SUBACCOUNTS FOR
Behavioral finance has also identified poor mental accounting as another reason people tend to undersave, says Madrian. Here’s how this one works: You probably have several long-term goals—college tuition for your kids, new living room furniture, a more fuel-efficient car, a beach vacation. You probably also save for many of those things in a single account. But having all the money in the same place can lead you to mentally overspend it. “You save $1, and you think, I’ve saved $1 extra for my vacation, $1 toward my car, $1 for furnishing the living room,” Madrian says. “But you haven’t saved $3 at all; you’ve saved $1.”
To fight this tendency, set up a system in which the money is earmarked. That means a college account, plus a vacation account, plus an emergency savings account. (Note: Keeping them all at the same bank should eliminate paying too much in fees; most banks now require you to keep a minimum deposit in all your accounts combined.) “This helps you realize how much you need to save for each particular goal,” Madrian says. (Don’t feel too bad about this misunderstanding. She notes that our government does it all the time: “When tax revenue goes up, the government thinks it can spend on schools and roads and health care.”)
DON’T DECIDE; AUTOMATE
As far as effective strategies go, the one with the most data behind it is setting up automatic transfers into your savings accounts. Here’s a bit of proof that it works: Nearly half of all 401(k) plans now automatically enroll their employees. At companies that auto-enroll, 80 to 90 percent of employees are in the plan, twice as many as in companies that don’t auto-enroll. And families with some kind of retirement plan have an average net worth of $860,000, nearly four times the average net worth of families without one.
If you work for a company that doesn’t offer a 401(k), you can fashion one for yourself. First, set up monthly automatic transfers into your retirement, college and savings accounts. Second, pick a date once a year when you’ll increase these amounts. And if you need a further push, make an appointment to do the paperwork with someone you trust financially. “Use the meeting as a disciplining device to get it done,” says Laibson, who also suggests giving yourself a deadline. He published research on a firm that told employees it needed to know within a month whether they would be signing up for the retirement plan. “Just doing that increased participation from 40 percent to 70 percent.”
For MORE of Jean Chatzky's money columns, click here.
Don’t miss out on MORE great articles like this one. Click here to sign up for our weekly newsletter!