When it comes to our personal finances we generally know the basics of what we need to do to be successful. Spend less than you earn. Stay out of credit card debt. Save a decent percentage of your income for emergencies and long-term planning.
But just because we know what to do doesn’t make it any easier. In fact, as a country our personal savings rate is quite low. According to the Federal Reserve, throughout the 1960s, 70s and 80s the personal savings rate of the country averaged 8-10% of disposable income. Then the stock market really took off in the 1990s and the average dropped to 5.5% because people assumed investment returns would make up the difference. The housing bubble of the early to mid-2000s dropped the rate even further in the first decade of the new century to 3.4%. The most recent reading in February of this year was 2.6%.
If we know we need to save more to reach our goals why is it so hard to put into action? One reason is that we live in a society that is short-term focused and we do not plan ahead for the future. Delayed gratification is no fun when I can get what I want now through a credit card purchase. And since we try to keep up with our neighbors, friends and co-workers we spend money out of envy for what others have.
But it is also hard to just get started. The number of options we have for the places you can save your money can be overwhelming. Plus, part of our human nature is that we can’t stand to lose money. Studies have shown that because of a tendency called loss aversion, losing something makes you twice as miserable as gaining something makes you feel good. So it hurts to see our discretionary spending budget suffer because of the need to save.
It would be nice if we could just all of the sudden start putting aside $500 a month (or whatever your goal amount is) into our retirement and emergency savings accounts but that’s tough to do if you are starting at a lower amount or possibly saving nothing at all. You will really notice the difference in your check book. And it will be hard to keep up the habit of saving if you try to do it all at once. It will be easier to say that it’s just too hard and quit altogether.
To remedy these problems we need to trick ourselves into saving more. The key is to start small and increase the amount you save incrementally. Start by making it your goal to save $50 to $100 a month. Have it taken out of your checking account automatically on the same day every month so you aren’t tempted to spend that money. Technology makes that really easy for us these days. Then increase the amount you save by $10 to $25 a month or quarter to slowly reach you goal.
This makes it much easier to accomplish since it won’t all happen at once. You can ease into it. And once you start seeing your balances slowly increase in size it will help your confidence and motivate you to stay on track to reach your goals.
Another way to trick yourself into saving more is by having the increases in the amount you save coincide with your annual raise at work. Shoot for at least 50-75% of your raise to go directly into savings. For example, if you get a 4% raise this year, increase the amount you contribute to your 401(k) by 3%. Have it start on the same paycheck as your new raise so you never even notice that the money is there in the first place. You still get a bump in your income and you won’t ever even see the extra amount you are saving and be tempted to spend it.
The same can be done when you refinance your house. With rates at historic lows you should be able to get some nice savings by lowering your mortgage rate. Instead of using that money for discretionary spending, increase the amount of your mortgage payment by the amount of your savings. You’ll still be saving the exact same amount only now you will be paying off your loan at a faster rate (saving you interest costs in the long-term).
Or take the difference and plough it into your emergency savings account each month. You are already used to paying that amount at the higher rate so your lifestyle will remain the same. The money is just working for you in a different place.
It would be nice if we could flip a switch to save the exact amount we want and didn’t have to trick ourselves into saving more. But the end result is what really matters and that is reaching your long-term goals. A little sleight of hand to get there can make that happen all the same.
Ben Carlson writes about personal finance, investing and investor psychology at A Wealth of Common Sense.