Saving for retirement is difficult because it requires self-control. Before the rise of the 401(k) plan in the late 1970s and the socializa­tion of investing (see Chapter 7), 51% of retired people had no income from financial assets. Only 22% of retirees earned investment income that contributed more than 20% of their total retire­ment income. Most of the retirees had succumbed to the desire of current consumption during their peak earning years and procrasti­nated saving for the future.6

If you're like most people, you probably find it easier to save from a lump-sum payment than from regular income. Consider two people who each earn $25,000 per year. The first is paid the $25,000 in 12 equal monthly payments. The second person earns $20,000 divided into 12 monthly payments and then receives a $5,000 bonus paid all at once. Since both people earn the same for the year, they should both save the same amount for retirement. However, the per­son with the bonus will probably save more. It is easier to come up with the disposable income to save with a lump-sum payment (or cash windfall). Saving money from a monthly salary requires much tries like Japan is higher than in the United States. A higher percentage of income in Japan is paid in year-end bonuses. It is easier to live on regular income and to save windfalls.

This may also explain the U.S. taxpayer's propensity for giving interest-free loans to the government. Most people have too much withheld for taxes throughout the year and then receive a tax refund in the spring. In 1996, approximately 76% of individual taxpayers overpaid an aggregate $117 billion on their taxes. That is a lot of for­gone interest!

You can easily adjust your withholding rate and retain more of your income during the year. However, you may actually prefer to overpay. In an experiment using MBA students and a case of a hypo­thetical wage earner, 43% of the 132 students chose to pay more than the minimum required quarterly tax payment.

IRAs

The individual retirement account (IRA) and the corporate 401 (k) pension plan are two savings innovations that can help you save and invest for the future. These plans are simple to implement and give you the added benefit of an immediate tax reduction. Additionally, the large penalties for early withdrawal help you with the willpower to keep the money invested for retirement. Most people who invest in an IRA or a 401(k) plan contribute again the following year; i.e., they form a habit to help their willpower.

It is clearly rational to contribute to an IRA. The investment earnings in an IRA grow tax deferred—you do not pay income or capital gains taxes on the profits in the year in which they are earned. Instead, you pay income taxes when you take the money out of the IRA after you retire. Therefore, it is best to contribute the money to the IRA as soon as possible to let it grow. For a particular tax year, you should contribute on January 1 of that year to get the maximum time benefit of the money growing. However, you probably do not have the self-control to invest early in the year. The tax laws allow contributions made as late as April 15 of the next year to count as the previous year's IRA. Indeed, most taxpayers contributing to an IRA will not contribute until the last few months before the IRA dead­line. They need the deadline to exert self-control.

401(k) Plans

Contributing to your 401(k) plan is also a very smart thing to do. Usually employers contribute at least some percentage of what the employee is contributing—e.g., if your company has 50% matching, for every $1.00 you put into your 401(k), the company puts in 50<t. Right off the top, before any money is invested, you've had a guaran­teed return of 50%. If a broker told you she had a stock for you that would give you a guaranteed 50% return the same day you bought it, you'd be running for the checkbook! Also consider that the 401(k) contribution is in pretax dollars. When you contribute $l,you get to keep the full $1 and get a 50$ match. However, if you get the $1 in your paycheck instead, you get only 65<t after federal, state, and social security taxes are taken out. Which do you prefer, $1.50 in investments or 65<P in your pocket? Most people's excuse for not signing up is that they can't afford it, but they really can't afford not to. However, since the inception of the 401(k), the most difficult aspect for plan administrators is getting employees to sign up and begin contributing in the first place. This is because people procrastinate even in the face of something that would give them huge returns! The more important the decision, the more likely it is that people will procrastinate.

Another reason for procrastination regarding 401(k)s may be related to the different investment options—employees often feel they can make a better decision about which options to choose if they just take a little more time to analyze the choices. This continu­ous delay costs the employee the two most important factors in building a retirement nest egg: time and invested capital. This prob­lem is getting worse because companies are increasing the number of options available in 401 (k) plans. These plans started out having three or four choices (typically, company stock, money market fund, bond fund, and stock fund). However, many plans now have mutual fund families with hundreds of different funds from which to select. Having more options available induces more procrastination. In order to help employees with self-control, some companies, as men­tioned earlier in this book, are now automatically signing employees up for 401 (k) contributions when they are first hired. That way, while employees procrastinate on how to change the automatic con­tribution defaults, they are still contributing and investing.

SELF-CONTROL AND INVESTING

Psychological factors affect not only your ability to save, but also your investing. Problems from overconfidence, aversion to regret, and pride seeking cause you to make poor decisions. If you recognize this problem, you can use rules of thumb and/or environment con­trol like we discussed earlier to help with investing self-control. For example, if you like to trade actively, you may realize this behavior is not optimal in the long term. As a compromise between the two selves (the planner and the doer),you open two brokerage accounts. One is for the majority of your wealth to implement a long-term buy-and-hold strategy, while you can use the other to "have fun." Of course, you could actively trade a small portion of your overall wealth all in just one account, but it would require self-control to actively trade only a small amount of capital. Having two accounts helps with self-control.

Many investors have neglected to practice self-control. Instead of controlling their environment, they have done just the opposite— they're letting the Internet environment control them. Unfortunately, the dark side of the financial services industry understands that behavioral aspects often drive investors' decisions. Boiler room brokers use high-pressure sales tactics designed to manipulate emotions and influence your behavior. You should have rules of thumb to help you avoid falling into their trap. Rules like

■    Never buy investments from a broker you don't know.

■    Never buy investments when the broker calls you. Investments that brokers are selling hard are rarely the type of investments you should be buying.