“For everything you have missed, you have gained something else.” ~ Ralph Waldo Emerson
Don’t be biased towards short term loss
‘Loss aversion’, from an investment perspective, refers to our tendency to avoid losses over acquiring gains. For example, we all know that sinking feeling when the market isn’t performing – it’s so tempting to cash out and limit further losses. But that kind of short-term decision-making is detrimental: If you disinvest, you will lose out big time when the bull starts running again.
The concept of loss aversion also relates to savings. We avoid saving because we place more value (too much value, if we’re being honest) on life’s little luxuries, like dinner out on a Friday night, or your daily latte at that hipster coffee shop outside your office. Loss aversion in this context refers to the perceived sense of missing out if we don’t treat ourselves – FOMO, in other words. But if you think long term and have dinner at home on some Fridays, and you bank the money you save, then you’ll be smiling in years to come.
Watch out for lifestyle creep
No, it’s not a Radiohead song… Lifestyle creep is closely related to loss aversion and it happens when you incrementally increase your standard of living (or simply maintain your standard of living despite inflation) as you earn more and have more discretionary income at your disposal. The deeper the creep, the more your thinking pattern tends to change – you begin to regard luxuries as your right, not as a privilege. It’s basically self-generated inflation, which does nobody any good!
Examples of lifestyle creep include flying business instead of economy class, buying a new car unnecessarily, or buying a bigger house in a swanky area and pushing your credit to the limit.
Want to hear a secret? Lifestyle creep doesn’t actually improve true quality of life, all it does is result in a financially stressful retirement.
Automatically increase your debit orders
Now that you’re aware of the dangers of loss aversion and lifestyle creep, what must you do with your salary increase? First up, you’ll need to cover the increase in essential expenses, such as medical aid, insurance premiums and school fees.
Once you’ve accounted for these unavoidable expenses, next on the list is increasing your contribution towards your retirement fund. This happens automatically if you’re contributing towards a company pension or provident fund, but you might have to implement the change yourself if you’re contributing towards a retirement annuity. When you make the change, make sure to also automate the annual increase. That way you won’t forget to increase your contribution again in the future.
Another constructive way to use your salary increase is to start an emergency fund, with a monthly contribution to a money market account, for example. Auto-escalation is your friend here again – it’s best to set it at 20%. When the value of your emergency fund reaches an amount equal to six months of your salary, you can start moving the excess into a discretionary investment for better long-term performance.
Health is wealth
Last but not least, there’s your health. If anything, this is the aspect of your life most obviously affected by your behaviour. There’s no point planning for retirement if you won’t be able to enjoy your golden years! Life is stressful and we’re all fragile, regardless of our age. Take a good look at your healthcare plan and make sure it’s comprehensive enough. Also consider purchasing gap cover, which is relatively inexpensive and comes into its own if you have to be admitted to hospital. And be sure to exercise both your body and your mind regularly.
At the end of the day, nobody is entirely rational – and nobody expects you to be. At the same time, however, it’s very helpful to understand your spending and investing behaviour. You don’t need to live like a Trappist monk, but it is worth making sure the money you’re spending on luxuries isn’t impacting your long-term investment goals. To make your life easier, go through all your important debit orders and make sure they automatically escalate each year.
Once you start saving, you’ll discover how easy and rewarding it can be. Remember that our door is always open if you want to chat about how to streamline your expenses and get your investments firing.