When browsing the questions on /r/personalfinance, I’m always shocked to see how many posts there are asking about how to save money. What they should be asking about is how to save money automatically.
I almost never take part in the act of saving. A computer does it for me. Every paycheck. Day-in, day-out. I don’t do anything. My company’s direct deposit. The automatic transfers initiated by my banks. The brokerage that automatically deducts money every two weeks to buy shares of mutual funds. Even my dividends automatically buy more shares of mutual funds.
The psychology of saving
Ok, first things first: I’m not a psychologist or a behavioral economist. But I can speak from personal experience when it comes to will-power saving versus automatic saving. Automatic saving is way easier.
Automatic saving works so well because humans, generally speaking, are lazy! We don’t like doing stuff. This is why every business’ dream is to have a service that is on some sort of automatic renewal or subscription. Our species just doesn’t want to get off our butts and cancel the service. In fact, we are so lazy, that we’d rather just pay the $8/month instead of figuring out how to cancel our subscription to Fine Glassware Weekly!
A real life example of how automation increases savings is with the good ol’ 401k. Employers have used automation to boost 401k plan participation up to about 85%. How? By making enrollment automatic instead of leaving it up to employees to sign themselves up. The best plans also have automatic increases.
When you take us, irrational and lazy humans, out of the mix, our savings grows like it should: with consistency. The computer will buy shares every two weeks whether or not the S&P 500 fell 40 points that day or not; whether we’re out of the country or right at home. The programs that the bank uses to automatically move your money are not susceptible to fear, forgetfulness, or impulsivity.
I’ve heard some say that the wealthy have to spend too much time managing their money to enjoy it. Nonsense. Using simple automation, you can become wealthy AND enjoy it. You’ll get to enjoy watching your money grow, but won’t have to worry about managing it.
What my setup looks like
So what does a really awesome automated money management system look like? There are probably about a thousand ways to do it, but I’ll show you what I do with a nifty little flow chart:
After my employer automatically ships off 14% of my salary to my 401k account, the rest goes to a checking account which acts as a hub for all other actions.
I set up automatic transfers for every bit of saving that I do: Roth IRA contributions, brokerage account contributions, etc. My wife and I each have our own little fun money accounts that we use for whatever we want and the other person isn’t allowed to judge.
By the Monday after payday, my checking account has only the money I need for the next two weeks. For things like the mortgage or electric bill that are paid on a monthly basis, half of the monthly amount due goes to my checking account each paycheck. For example, our electricity bill is generally around $150/month. Each paycheck, we set aside $75 for it. The only other money in the checking account is what is spent on groceries, gas, mortgage, etc. In other words, only what we need! This helps prevent over spending since the checking account doesn’t have much wiggle room. In fact, we have our bank options set so that automatic overdrafts are not allowed–my debit card will be declined if we run out of money!
Two times a year, we get paid three times in a month. These are the only times that I manually save money since bills like the mortgage are taken care of after two paychecks. The extra money from the third paycheck usually goes to the brokerage account.
In summary, the money flow looks like this:
- $190 to the Roth IRA*
- $50+ to the Emergency Fund
- I do this as a way to replenish the fund. I end up using the fund every once in awhile and I contribute a little bit each paycheck to float it back up.
- $100 to each my wife and my own “fun money” checking account.
- As much as possible to a brokerage account that invests in a low-cost index fund that tracks the S&P 500.
Tools for success
There are some tools you should probably use to help you succeed in this. First and foremost, you need a bank that will let you do automatic transfers. Not to fear though; this is almost a universal feature now. You’ll have to snoop around online on your bank website to find it. If you get lost, call them! As a last resort, switch banks. You need this feature.
Once you set up all of your deposits, it is a really good idea to use a free program like Personal Capital to get an overview of what’s going on. These services will show you how your money is moving all on one screen. It’s a nice way to see money leaving your checking account and going towards your savings or brokerage account. It truly is fun to wake up on payday, check Mint, and see that money has been moved around just as you ordered it to.
- Work with your employer to make sure your paycheck is direct deposited to your checking account. Your checking account is the main hub for all automatic transfers.
- Follow Phases 2-7 to determine which accounts to start automatic transfers to. If you don’t have an emergency fund yet, then start transferring money there. If you’ve already got an e-fund, then contribute to your Roth IRA, and so on.
- Start today! Make sure to set the payments as recurring. Monthly or every other week works best. Recurring is the key word here. Consistency is what builds wealth.
*This is exactly what I’m talking about when I talk about laziness. $190/paycheck comes out to about $5,000/year–which was the Roth IRA limit when I first started contributing. I’m too damn lazy to bump it up $210/paycheck to hit the new $5,500/year limit even though I know that I should.