It’s often said that time is money. This comparison is even more apt that we might think. In the same way that we never seem to have enough hours in the day, many of us often spend all the money we make (and sometimes more than that!).
But given that we all make a finite amount of money and we all have to find a way to live within that constraint, how can we maximize the amount we are saving?
The answer lies in psychology. Simply put, if you don’t see the money, you won’t think to spend it. In the personal finance blogosphere, this is often called “paying yourself first.”
Your 401k is a great example of this principle at work. Your employer automatically sets aside a pre-specified amount and puts it into your retirement account. There is no manually deciding to transfer the funds from one account to another. It just happens. And there’s an added bonus. If your employer offers a 401k matching program, they’ll contribute the same amount you do to your 401k (to a limit). That’s basically free money!
Why Pay Yourself First?
You’re developing good habits
Like any other habit, developing good financial habits can be extremely challenging. Especially if you find yourself falling victim to “shiny object syndrome.” By establishing an automated savings program, you take the decision making out of the process and implement a habit in the easiest way possible. It’s literally a no-brainer!
Most people spend their money in the following order: bills, fun stuff and shopping, then saving. Doing it this way, to our earlier point, leaves very little allocated to savings once all is said and done. By paying yourself first, you are moving the last step to the front and completely re-categorizing saving as a non-negotiable item.
You’re Prepared for Emergencies
Saving well is much more than a number on a screen. It’s the peace of mind that comes with knowing you’ve built yourself a cushion for life’s unexpected events. This reduces your stress and in turn, helps vastly increase the quality of your life.
Almost 80% of Americans find themselves living paycheck to paycheck. This means that 4 our of 5 people you know wouldn’t be able to support themselves for even a short period without an income. Living this way causes a massive amount of stress and is part of the reason that the number one thing married couples fight about is money.
You can help yourself avoid all that additional stress by saving early and saving often. Even if it has to start as extremely small amounts, any amount of savings is better than none.
You’re Prioritizing Your Financial Future Over Today’s Spending
In the 1960s, a Stanford professor named Walter Mischel conducted a psychology experiment that has since become known simply as “The Marshmallow Experiment.”
The experiment was simple enough. A researcher brought a child into a room and placed a marshmallow in front of them. The researcher then offered the child a deal: eat the single marshmallow now or wait for him to come back into the room 15 minutes later and get an additional marshmallow.
What made this experiment interesting came many years later. As researchers followed up with the children from the experiment, they concluded that the small group who delayed gratification were more successful across almost any metric than those that didn’t.
The lesson here is that there is tremendous power in delaying gratification.
By saving now, you are granting your future self the freedom to worry less about money. In the process, you’re also allowing yourself to benefit from the power of compounding and exponential growth, meaning the longer you delay withdrawals, the greater your reward will be. It’s a test of willpower, to be sure, but one that offers incredible rewards if successful.
Setting Up the Self-Payment Machine
We can apply this principle in other ways too. Fortunately, the financial technology industry is going through somewhat of a renaissance right now and there are plenty of options at our fingertips to automate this sort of investing behavior. I personally have this set up in four separate (but similar) ways.
The first two methods are automated by my employer. My 401k is one the first. Second, I set aside a specified amount from each paycheck that is deposited into a taxable investment account. This is the account where I invest in single name stocks that I believe will appreciate in value or produce consistent dividends. Similar to the 401(k), this amount comes out of my paycheck automatically and I never see it.
The third and fourth methods I use leverage the incredible technology we have at our fingertips today. I have accounts with both Acorns and Wealthfront. These companies both fall under the umbrella term “robo-advisors” but their methods of adding balances are extremely different. Both companies invest in a portfolio of low-fee ETFs according to a preset risk profile. Where they differ is in how they add balances.
With Wealthfront, I set up an automatic withdrawal from my checking account on a weekly basis (unfortunately, they don’t let you do deposits more frequently than that). This automatic withdrawal is different in that it does actually hit my checking account before it is allocated. But because I never have to make the choice to invest it, I still don’t think about the money as “spendable.”
These days, robo-advisors are the the investing option of choice, especially for millennials. As such, there’s been a bit of a gold rush by both traditional banks and new entrants to establish reputable platforms and grow assets under management. While there are a TON of robo-advisors to choose from, some of the most popular options include Betterment, Vanguard, Charles Schwab, and WiseBanyan. Each one offers different features and one day I will do a detailed comparison of all of them, but for now it’s up to you to find the one that fits you best.
Acorns is even more clever. Their model works by “rounding up” all the purchases you make on a day to day basis. Your Acorns account is connected to your credit cards (and debit cards, bank accounts, whatever) and when you make a purchase they round to the nearest dollar and invest that incremental amount for you. Let’s say you buy a coffee from Starbucks for $4.32. Acorns will take the $0.68 to round up to $5 and invest it into your account. I was shocked by the rate at which I was able to save a substantial amount of money using Acorns without even thinking about it.
Acorns also has a few more ways to accelerate your savings. You can implement a round-up multiplier, which would take the $0.68 from above and multiply it by either 2x, 3x, or 10x. So your $0.68 could mean as much as $6.80 invested in your future! Pretty powerful stuff! You’re also able to institute recurring fixed amount deposits as frequently as daily. And of course, you can make a one-time deposit whenever you want. All these methods combine into one incredibly powerful brain hack that allows you to much more efficiently save money.
There are of course several other options that achieve similar ends. Some of the more popular ones on the app store are Stash and Digit. I do not have personal experience with either but one of these may meet your personal goals more than mine.
Hopefully, you recognize the importance of ramping up your savings today so you’ll be bale to relax in the future. For so many people, money presents a constant source of stress. It doesn’t have to be that way and fortunately, you have the power to construct your finances in such a way that you will better manage and avoid that stress. Control of your finances is possible, you just have to shake off some of the conventional attitudes about money to leverage its true power.
Remember, personal finance is a contact sport but it’s also a very long game. You may not see huge benefits from savings today, especially small amounts, but I can assure you that over a long time horizon you will begin to see incredible benefits from such consistent prudence. Happy saving!