Five 'nudges' that will make you money

There's little that's genuinely new in economics and finance. The principles that govern our understanding are little changed over the last century. But one of the truly new parts of economic theory is the belated realisation - or perhaps we should say acceptance - that people aren't the purely rational automatons that the academics had previously assumed.

As far back as the 1930s, Warren Buffett's mentor Ben Graham was talking about it - but it took economists almost half a century to catch up, thanks mainly to the work of two behavioural psychologists, Danny Kahnemann and Amos Tversky.

The gist - obvious in hindsight - is that humans aren't always rational. But when we try to be rational, our brains play tricks on us. And, to compound the error, even when we know that, those tricks are still awfully hard to avoid. We are - at the same time - the lucky recipients of billions or years of evolution, and prisoners to it.

The good news is that we can overcome these biases - mostly by avoiding temptation. If we can make (some) decisions in advance, they can save us from ourselves.

Here's five things - little 'nudges', to use the academic vernacular - that can help:

Payroll deduction for Super contributions

Humans are bad at sacrificing today for a better tomorrow (see: Politics, 2017). And that's doubly true when we have to do it manually, on a regular basis, such as making additional Super contributions. Super itself is a form of nudge, of course, but if you can, try to add another couple of per cent of your salary or wage to Super, using a payroll deduction. Chances are, you'll never notice it, until you're pleasantly surprised at retirement.

Split your salary

Speaking of which, most employers will let you use the very same approach to have your pay split into different accounts. Most pundits, including yours truly, encourage you to save 10 per cent of your pay and invest it -- and this is a great way to automate that process, avoiding both temptation and laziness.

Use cash

For the kids reading this, cash was what we had before credit cards, PayPal and Apple Pay. For the rest of us, cash has a wonderful ability to limit what we spend. Next time you go shopping, decide in advance how much you're prepared to spend, and withdraw it from an ATM in cash. Then leave the credit card behind. Don't have enough cash now? Save.

Dollar cost averaging

This clunky term is what the boffins use to describe small regular investments. It's tempting to think 'I'll wait until the market falls' or 'I'll wait until I have more money to invest'. Those tomorrows often don't come. Automating your investing - by buying shares on a schedule every month or every quarter - relegates those fears. When prices are low, you'll buy more shares, and fewer when they're high??? but you'll keep buying. And the latter is the key.

Quarantine - and reinvest - dividends

When you get your dividend cheques -- or direct deposits -- it can be tempting to spend the windfall. But up to 50 per cent of long-term investment returns come from reinvested dividends. So open a separate account (or use the account you 'split' your saving money into, above), to bank your dividends, then use that account only to buy more shares.

Foolish takeaway

We all want to think we're smart. And rational. 90% of us think we're better than average drivers, too. Even if we're all of those things, our minds sometimes still work against us. Recognising that, and adopting some 'nudges', is the best antidote. 'Future you' will thank you for it.

Scott Phillips is the Motley Fool's director of research.

The story Five 'nudges' that will make you money first appeared on The Sydney Morning Herald.

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