Everybody knows that bad habits can be harmful.
To help you overcome three of the most common bad money habits, the editors of Consumer Reports Money Adviser identified symptoms to help you diagnose problems as well as effective prescriptions to help you get back into top fiscal condition.
1. HYPERCUSHIONOSIS
You keep enough cash in your checking account to finance the next Gulf War. Perhaps you keep it in a place where it pays you no interest because you’re nervous about making decisions. Or maybe having a five-figure emergency cushion makes you feel secure. But you don’t need all that money to pay your bills each month. You can do better shifting some money into an investment.
Our prescription: You’ve got to get some of this money out of your checking account, where it’s doing absolutely nothing. Start by transferring $5,000 or $10,000 or more to, say, a balanced mutual fund or an asset-allocation fund, which would give you a mix of stocks and bonds. If you can’t give up your cushion all at once, deflate it gradually. Get on the phone with a mutual-fund company with whom you’ve done business and ask for an automatic money transfer for, say, $500 a month. The fund company will electronically dip into your account and deposit the money in funds you designate. You can stop withdrawals when your cushion gets too thin.
2. FINEPRINTPHOBIA
That investment in Fannie Mae mortgage securities seemed like a dream, especially after you started receiving huge monthly payments. It was only after you spent all the money that you realized some of it was a return of your own initial investment. And how were you to know that the 0 percent rate on your credit card applied only to balance transfers and not to the new purchases you piled up? There always seems to be some nasty detail you didn’t notice in every financial transaction.
Our prescription: Many financial offerings have catches that can cost you. Chances are, however, you fear and loathe reading the prospectuses, cardholder agreements, and other fine print that disclose said catches to the public. But in choosing financial products, assiduous attention to detail pays off. How can you focus your brilliant mind on such lowly detail? Make a game out of it. When you read a financial disclosure, see how many fees or catches you can find.
In a variant of the syndrome, you act on recommendations of a broker or financial adviser without asking too many questions. After all, the dunderhead seems to be telling you what you already know. Believe us, you may not know. For relief from this affliction, play 20 Questions. No matter how flat-footed your questions sound, the answers your adviser gives you will say volumes about what you’re getting into, especially when you start inquiring about fees and commissions.
3. MARTHA STEWART DISORDER
Somebody on TV said that stock in Okeydoke Sciences, a new biotech company trading at $5 a share, would hit $45 by July. You called your broker and bought, and now it’s trading at $4.50. Then, after you read a critical story about Target in the newspaper, you dumped your shares, but two months later they were up 30 percent so you bought them back. After a couple of years, you notice that you’ve racked up hundreds of dollars in trading commissions, and your portfolio has dropped in value by 10 percent.
Our prescription: Laziness and inertia often produce higher returns than alertness and alacrity. Witness the experience of the so-called domestic diva. When her broker called to tell her that her stock in ImClone was probably heading downward after the Food and Drug Administration would not accept a filing for Erbitux, ImClone’s cancer treatment, Stewart sold her stock at $58 and ended up in prison.
Terrance Odean and Brad Barber, both professors of finance at the University of California, the former at Berkeley and the latter at Davis, would have told Stewart to ignore her broker. The two studied trading records of 88,000 investors over 10 years at a large brokerage house and found that the more actively investors trade, the less they earn. Indeed, the 20 percent of investors who traded most reaped an average net annual return that was 5.5 percent less than that of the least- active investors.
To insulate yourself from all the voices telling you to sell and buy, refrain from watching finance shows on TV and instead “go to the movies,” Odean says. He suggests that investors settle on a sensible asset allocation, say 40 percent bonds and 60 percent stock, and then put their money into no-load index funds with low expense ratios. “Then let it ride,” Odean counsels. You only need look at your investments once a year and rebalance your portfolio if it no longer meets your needs. Side note: In July 2004, four months after Stewart’s conviction, ImClone’s stock rose to $87. (Now it’s trading around $39 a share.)